The Pros and Cons of Perpetual Futures in Crypto Trading

When discussing crypto trading with experienced traders, the topic of perpetual futures, or 'perps', often comes up. These derivatives contracts allow traders to control large positions with minimal capital. Perps function similarly to standard futures, but without an expiry date. For traders of alternative cryptocurrencies, perps are often the only viable option for derivatives trading, as dated futures for these assets are typically illiquid. In contrast, spot markets are often an afterthought for traders who don't plan to hold onto their assets long-term. Traders who have found success in the perpetual futures market attribute their success to the deep liquidity, low trading fees, and high margin efficiency of perps. However, they also express concerns about funding rates, which can add up over time and negatively impact their 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 many; for a crypto-native firm, they are the primary tool.' Kenneth Ong, an independent trader, shares a similar perspective. He notes that perps offer better fills, lower fees, and the ability to run both long and short positions simultaneously via hedge mode. This allows traders to hold both bullish and bearish bets on the same token at the same time, without having to net their positions against each other. Ong started trading in the spot market but eventually shifted his focus to perps due to their advantages. For him, spot trading is now primarily for long-term holdings. Both Ong and Krenn emphasize that margin efficiency is a major draw for perps. Since perps require only a fraction of a position's value as collateral, traders can split their capital across multiple venues and still maintain meaningful positions. The perpetual nature of perps has also shifted the dynamics of price discovery. Instead of being limited to traditional market hours, price discovery can now occur at any time, as news breaks and markets react. Ong recalls the Iran conflict, where tokenized oil trading on Hyperliquid saw a significant surge in volume over a weekend, while traditional markets were closed. By the time traditional markets opened, a significant portion of the price adjustment had already occurred. Krenn sees this same mechanism playing out in perps tied to other traditional assets. He notes that building a proper tokenized equity product is challenging due to the need to recreate the legal, operational, and regulatory framework of traditional share ownership on-chain. Perps, on the other hand, can reference the price of an asset without requiring this infrastructure, making them a more practical option for traders. Both traders believe that the 'perpification' of various assets will continue to gain momentum in the coming years. Ong notes that tokenized oil trading over the weekend is a preview of what's to come for other commodities. As liquidity deepens across commodities and equities, it will become less necessary to use dated futures. However, there is a significant concern surrounding perps: the funding rate. While dated futures contracts provide a clear interest rate, perps have a funding rate that changes over time and is typically charged every eight hours. This leaves traders exposed to a floating rate, with no built-in mechanism to lock it in. If the market doesn't move as expected, the funding rate can become a significant burden. Krenn and Ong both express concern about the funding rate, with Ong noting that it can 'potentially balloon to the point where a profitable trade loses money.' The issue of funding rates is further complicated by the fact that they can be difficult to quantify and hedge. Krenn notes that the problem is not with perps themselves, but rather with the crypto exchange margin model. He argues that the distinction between perpetual and dated futures is less important than the difference between facing a proper clearing house with a mutualized default fund or an exchange that socializes losses onto winners. Krenn also offers an insight that challenges common assumptions about perp risk. He notes that being long is often the structurally safer side, as positive funding is easy to arbitrage away. However, when the funding rate is negative, the arbitrage becomes more difficult, and the gap between perp and spot prices can persist. This means that funding rates can remain extremely negative for long periods, making the long side have a bounded cost and an unbounded upside, while the short side has a bounded upside and an unbounded cost. 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 can't be quantified or hedged. 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.'