The Double-Edged Sword of Perpetual Futures: Benefits and Drawbacks According to Crypto Traders

When discussing crypto trading with experienced traders, the conversation often revolves around perpetual futures, or 'perps' - a type of derivatives contract that enables traders to control larger positions with minimal account holdings. Perps function similarly to standard futures but lack an expiration date, making them a unique and attractive option for traders. For bitcoin and ether traders, perps are just one of many available derivatives, including spot, futures, options, and structured products. However, for traders of other altcoins, perps may be the only viable derivatives option due to the illiquidity of dated futures and the spot market. To better understand the role of perps in the crypto market, CoinDesk spoke with traders who have thrived in the perpetual futures market. They explained what sets perps apart from other derivatives, how perps efficiently manage the needs of both institutional and retail traders, and the associated costs of perps trading. The traders' responses were overwhelmingly positive, citing the deep liquidity, low trading fees, and high margin efficiency of perps as major advantages. Margin efficiency refers to the amount of trading exposure achievable per unit of collateral posted. However, the traders also expressed concerns about the funding rates, which are recurring costs for maintaining open positions. Funding rates can be thought of as interest charges that accumulate over time, and traders are worried about the potential impact on their profits. So, why do traders prefer perps? The answer lies in their necessity, particularly for crypto-native firms. According to Lucas Krenn, a derivatives trader at STS Digital, perps are the foundation of the firm's operations, especially for altcoins with limited dated futures liquidity. Dated futures are less popular due to the costs associated with replacing contracts at expiry, which also affects the efficiency of futures-based ETFs. Perps offer better liquidity, allowing for larger buy and sell orders at stable prices, whereas dated futures are often illiquid, making them more susceptible to price swings. Kenneth Ong, an independent trader, shared a similar perspective, highlighting the benefits of perps for retail traders, including better fills, lower fees, and the ability to hold both long and short positions simultaneously via hedge mode. Ong started in the spot market but transitioned to perps due to their advantages, now using spot primarily for long-term holdings. Both Krenn and Ong emphasized the importance of margin efficiency in perps, which enables traders to manage risk efficiently across different venues and tokens. Perps require only a fraction of the position's value as collateral, allowing traders to split their capital across multiple venues and maintain meaningful positions. The perpetual nature of perps has also shifted price discovery to occur around the clock, rather than only during market hours. Ong recalled an instance during the Iran conflict, where tokenized oil trading on Hyperliquid saw a surge in volume over a weekend, with the 'official' market closed. By Monday, a significant portion of the repricing had already occurred in the crypto/tokenized commodity perps market. Krenn sees this mechanism playing out in perps tied to other traditional assets, such as tokenized equities, which can sidestep the complexities of traditional share ownership. Both traders believe that the 'perpification' of various assets will gain momentum in the coming years, with Ong citing tokenized oil trading as a preview of what's to come for other commodities. However, they also warned about the funding rate, which can be a significant concern for traders. Unlike dated futures contracts, which have a fixed interest rate, perpetual futures contracts have a funding rate that changes over time and is typically charged every eight hours. This exposes traders to a floating rate while holding a position, with no built-in mechanism to lock it in. If the market doesn't move as expected, the funding rate can become a burden, and it's unquantifiable at the point of trade and unhedgeable afterwards. Ong expressed his concern, stating that the funding rate is not a tiny fee that can be ignored, especially for long-term positions, as it can potentially balloon and turn a profitable trade into a loss. The traders also addressed the myth of the safe trade, citing the October 10 crash, which triggered widespread deleveraging across both losing and profitable positions. Krenn argued that the problem wasn't with perps but rather with the crypto exchange margin model, which socializes losses onto winners. He emphasized that the distinction between perpetual and dated futures is not the primary concern; instead, it's whether traders are facing a proper clearing house with a mutualized default fund or an exchange that socializes losses. Krenn offered an insight that inverts the common assumption about perp risk, stating that being long is structurally safer due to the ease of arbitraging away positive funding. However, when the funding rate is negative, the arbitrage involving a long position in the perp and a short position in the spot becomes more challenging, allowing the gap between perp and spot prices to persist. This can result in extremely negative funding rates for extended periods. In conclusion, perps have democratized futures trading by addressing issues of access, cost, and margin efficiency, but they are not without unique challenges, particularly the volatile funding-rate exposure that cannot be quantified or hedged. As Krenn put it, until a liquid dated curve exists in crypto, the market will carry an interest rate exposure that cannot be priced or hedged, making funding a tax that everyone pays for easy access to this leveraged market.