The Double-Edged Sword of Perpetual Futures: Insights from Crypto Traders

Discussing crypto trading with experienced traders often leads to conversations about perpetual futures, or 'perps', which are derivatives contracts allowing traders to control larger positions with less capital. Unlike standard futures, perps have no expiry date. For traders of alternative cryptocurrencies, perps are often the only available derivatives option, as dated futures for these coins are typically illiquid. CoinDesk spoke with traders who have thrived in the perpetual futures market to understand what sets perps apart, how they cater to the needs of both institutional and retail traders, and the associated costs. The traders praised perps for their deep liquidity, low trading fees, and efficient margin usage, which enables greater trading exposure with less collateral. However, they also highlighted the funding rate, a recurring cost for maintaining open positions, as a significant concern. The funding rate can be seen as an interest charge that accumulates over time, and traders are worried about its potential impact on their profits. So, why do traders prefer perps? According to Lucas Krenn, a derivatives trader at STS Digital, perps are the primary tool for crypto-native firms due to their liquidity and efficiency. Dated futures, on the other hand, are often replaced with new contracts at expiry, incurring additional costs. Perps offer better fills, lower fees, and the ability to run both long and short positions simultaneously via hedge mode, making them an attractive option for retail traders like Kenneth Ong. Ong started trading in the spot market but shifted to perps due to their advantages. Both Krenn and Ong emphasize that margin efficiency is a significant draw to perps, as they require only a fraction of a position's value as collateral, allowing traders to manage risk efficiently across different venues and tokens. The perpetual nature of perps has also shifted price discovery to occur around the clock, rather than just during market hours. This was evident during the Iran conflict, when tokenized oil trading on Hyperliquid saw a surge in volume over a weekend, with the market reacting to news before traditional markets opened. Krenn and Ong see perps playing a crucial role in the future of trading, with the potential to spread into new asset classes. However, they also warn about the risks associated with perps, particularly the funding rate, which can be volatile and difficult to quantify. The funding rate is typically charged every eight hours and can become a burden if the market doesn't move as expected. Krenn and Ong stress that the funding rate is a cause for concern, as it can potentially turn a profitable trade into a loss. The issue of funding rates is further complicated by the lack of a built-in mechanism to lock in the rate, leaving traders exposed to floating rates. The traders also discuss the myth of the 'safe trade', highlighting the risks associated with perps, particularly during times of market volatility. Krenn argues that the problem lies not with perps themselves but with the crypto exchange margin model. The distinction between perpetual and dated futures is not as important as the presence of a proper clearing house with a mutualized default fund. Krenn also offers an insight into the asymmetry of perp risk, suggesting that being long is the structurally safer side due to the ability to arbitrage away positive funding. 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 not accounted for in risk models, leaving traders vulnerable to unexpected losses. In conclusion, perps have democratized futures trading by providing access, cost efficiency, and margin efficiency, but they also come with unique challenges, particularly the volatile funding-rate exposure. As Krenn puts 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.' For now, funding is the tax everyone pays for easy access to this leveraged market.