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

When discussing crypto trading with experienced traders, perpetual futures, or 'perps,' are often the first topic that comes up. These derivatives contracts allow traders to control large positions with minimal capital. Unlike standard futures, perps have no expiration date, making them a unique and attractive option for traders. For altcoin traders, perps are often the only viable derivatives market, as traditional futures contracts for these assets are typically illiquid. The spot market is also less appealing for traders who don't plan to hold onto their assets long-term. To understand what makes perps so popular, we spoke with traders who have thrived in this market. They cited the deep liquidity, low trading fees, and high margin efficiency as major advantages. However, they also expressed concern over the funding rates, which can add up over time and eat into profits. So, why do traders prefer perps? According to Lucas Krenn, a derivatives trader at STS Digital, perps are the backbone of their trading operations. 'Outside of bitcoin and ether, dated futures liquidity is thin to the point of being unusable,' he said. 'Perps are not just one tool among many; for a crypto-native firm, they are the primary tool.' Krenn explained that dated futures contracts have to be replaced at expiration, which can be costly. This process also makes futures-based ETFs less efficient than spot ETFs. Kenneth Ong, an independent trader, shared a similar perspective, highlighting the benefits of perps for retail traders. Ong noted that perps offer better fills, lower fees, and the ability to run both long and short positions simultaneously. This is a significant advantage over traditional futures contracts, which often require separate accounts for long and short positions. Ong started trading in the spot market but eventually shifted to perps due to their superior liquidity and margin efficiency. Both Krenn and Ong emphasized that margin efficiency is a key draw for perps. With perps, traders can control large positions with minimal capital, making it easier to manage risk across different venues and tokens. The always-on nature of perps has also changed the way price discovery works. Instead of being limited to traditional market hours, price discovery can occur at any time, as news breaks and markets react. Ong experienced this firsthand during the Iran conflict, when tokenized oil trading on Hyperliquid saw a surge in volume over a weekend. 'That opening weekend, all the real reaction happened on crypto/tokenized commodity perps while the 'official' market was closed,' he said. Krenn sees this same mechanism playing out in perps tied to other traditional assets. For instance, building a tokenized equity product is complex and requires recreating the full legal and regulatory framework of traditional share ownership on-chain. Perps that reference the price of these assets can sidestep these issues, making them an attractive option for traders. However, perps also come with unique challenges, particularly when it comes to funding rates. A dated futures contract provides a clear interest rate upfront, whereas a perpetual futures contract has a funding rate that changes over time and is typically charged every eight hours. This exposes traders to a floating rate while holding the position, 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 noted that this funding rate is 'unquantifiable at the point of trade and unhedgeable afterwards.' Ong was more blunt, stating that 'if you hold positions for long periods, 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 perps are often traded on exchanges with socialized loss models. During the October 10 crash, exchanges liquidated long positions and force-closed profitable shorts to protect their own systems. Krenn argued that this was not a problem with perps themselves, but rather with the exchange's margin model. 'It is not a perpetual problem; it is a crypto exchange margin model problem,' he said. The distinction that matters is not between perpetual and dated futures, but rather between facing a proper clearing house with a mutualized default fund or an exchange that socializes losses onto winners. Krenn also offered an insight that challenges conventional wisdom about perp risk. He argued 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 becomes more difficult, and the gap between perp and spot prices can persist. This means that funding rates can stay extremely negative for long stretches. As a result, the long side has a bounded cost and an unbounded upside, while the short side has a bounded upside and an unbounded cost. This asymmetry is not well-represented in most risk models. In conclusion, perps have democratized futures trading by solving the problem of access, cost, and margin efficiency. However, they are not without unique pain points, particularly when it comes to volatile funding-rate exposure. 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.' For now, funding is the tax everyone pays for easy access to this leveraged market.