The Double-Edged Sword of Perpetual Futures in Crypto Trading

When discussing crypto trading with experienced traders, the topic of perpetual futures, or 'perps,' inevitably arises. These derivatives contracts enable traders to control large positions with minimal capital. Unlike traditional futures, perps have no expiration date, making them a vital tool for traders. For altcoin traders, perps are often the only viable option for derivatives trading, as dated futures contracts for these assets are typically illiquid. The spot market is also not a viable option for short-term trading. To understand the appeal of perps, CoinDesk spoke with traders who have thrived in the perpetual futures market. They cited deep liquidity, low trading fees, and efficient margin usage as the primary advantages of perps. However, traders also expressed concerns about funding rates, which are recurring costs associated with keeping positions open. These rates can add up over time and eat into traders' profits. So, why do traders prefer perps? According to Lucas Krenn, a derivatives trader at STS Digital, perps are the foundation of his firm's trading activities. 'Outside of bitcoin and ether, dated futures liquidity is thin to the point of being unusable,' he explained. 'Perps are not just one tool among several; for a crypto-native firm, they are the primary tool.' Krenn attributed the lack of popularity of dated futures to the costs associated with replacing contracts at expiration. This process can be expensive and inefficient. In contrast, perps offer better liquidity, allowing traders to execute large buy and sell orders at stable prices. Kenneth Ong, an independent trader, echoed Krenn's sentiments, highlighting the benefits of perps for retail traders. Ong noted that perps provide better fills, lower fees, and the ability to run both long and short positions simultaneously. This is particularly advantageous for traders who want to hedge their bets. Both Krenn and Ong emphasized the importance of margin efficiency in perps. Since perps require only a fraction of the position's value as collateral, traders can split their capital across multiple venues and tokens, managing risk more efficiently. The perpetual nature of perps has also shifted price discovery to a 24/7 process, rather than being limited to traditional market hours. Ong recalled an instance during the Iran conflict, where tokenized oil trading on Hyperliquid saw a significant surge in volume over a weekend. By Monday, the market had already repriced, demonstrating the always-on nature of perps. Krenn believes that perps will continue to gain traction in the coming years, spreading into new asset classes. He cited the example of tokenized equities, which can be traded using perps without the need for recreating traditional share ownership infrastructure. However, Krenn and Ong also warned about the risks associated with perps, particularly the funding rate. Unlike dated futures contracts, which have a fixed interest rate, perps have a funding rate that changes over time and is typically charged every eight hours. This exposes traders to a floating rate, making it difficult to quantify and hedge against. 'It's unquantifiable at the point of trade and unhedgeable afterwards,' Krenn warned. Ong was more blunt, stating that the funding rate 'can potentially balloon to the point where a profitable trade loses money.' The traders also addressed the myth of the 'safe trade,' citing the example of the October 10 crash, which triggered widespread deleveraging across both losing and profitable positions. Krenn argued that the problem was not with perps themselves, but rather with the crypto exchange margin model. 'It's not a perpetual problem; it's a crypto exchange margin model problem,' he said. Krenn also offered an insight that challenges the conventional wisdom about perp risk. He claimed that being long is the structurally safer side, as positive funding is easy to arbitrage away. However, when the funding rate is negative, the arbitrage is more difficult, and the gap between perp and spot prices can persist. This asymmetry is often overlooked in risk models, according to Krenn. In conclusion, perps have democratized futures trading by solving issues of access, cost, and margin efficiency. However, they are not without unique challenges, particularly the volatile funding-rate exposure that cannot be quantified or hedged. As Krenn put it, 'Until there is a liquid dated curve in crypto, the whole market is carrying an interest rate exposure it cannot price and cannot hedge.'