The Double-Edged Sword of Perpetual Futures in Crypto Trading

When discussing crypto trading with experienced traders, perpetual futures, or 'perps,' are often the first topic that comes up. These derivatives contracts enable traders to control larger positions with less capital, and they don't have an expiration date like standard futures. For traders of alternative cryptocurrencies, perps may be the only viable option for derivatives trading, as dated futures contracts for these assets are often illiquid, and the spot market is not a priority for those who don't plan to hold onto their assets long-term. CoinDesk spoke with traders who have thrived in the perpetual futures market to understand what sets perps apart from other derivatives, how they cater to the needs of both institutional and retail traders, and the costs associated with perps trading. The traders' responses were overwhelmingly positive about perps, citing their deep liquidity, low trading fees, and efficient margin usage, which allows for greater trading exposure with less collateral. However, they also expressed concerns about funding rates, a recurring cost for maintaining open positions. Funding rates can be thought of as an interest charge that accrues over time, and traders are worried about how much this could add up to. So, why do traders prefer perps? According to Lucas Krenn, a derivatives trader at market-making firm STS Digital, perps are the foundation of the firm's operations. 'Outside of bitcoin and ether, dated futures liquidity is extremely thin, making perps the go-to tool for crypto-native firms,' he said. Krenn explained that dated futures contracts are less popular because they need to be replaced with new contracts at expiration, which incurs costs. These costs are also why futures-based ETFs are often less efficient than spot ETFs. Kenneth Ong, an independent trader with most of his activity in perps, shared a similar perspective from a retail trader's point of view. Ong stated that perps offer better execution prices, lower fees, and the ability to hold both long and short positions on the same token simultaneously via hedge mode. This is a significant advantage over regulated venues like the CME, which typically net positions by default. Ong started trading in the spot market but shifted almost entirely to perps after discovering their benefits. For him, spot trading is now mainly for long-term holdings. Both Ong and Krenn emphasized that margin efficiency is the primary draw to 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 changed how price discovery occurs, as it happens whenever news breaks, not just during market hours. Ong recalled an instance during the Iran conflict when tokenized oil trading on Hyperliquid saw a significant surge in volume over a weekend, and by Monday, much of the price adjustment had already occurred. Krenn sees this mechanism playing out in perps tied to other traditional assets as well. He noted that building a proper tokenized equity product is challenging because it requires recreating the legal, operational, and regulatory framework of traditional share ownership on-chain. Perps that reference the price can sidestep these issues, making them appealing for traders rather than long-term investors. Both traders believe that the 'perpification' of various assets will gain momentum in the coming years. Ong thinks that tokenized oil trading over weekends is a preview of what's to come for other commodities, and as liquidity deepens across commodities and equities, it will reduce the need for dated futures. However, traders also cautioned about the funding rate, which can be a significant concern. 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. Krenn described it as 'unquantifiable at the point of trade and unhedgeable afterwards.' Ong was more blunt, stating that the funding rate is not a minor fee and can potentially turn a profitable trade into a loss if held for an extended period. The traders also addressed the issue of liquidations and the socialization of losses on crypto exchanges. Krenn argued that the problem lies not with perps but with the crypto exchange margin model. He emphasized that the distinction between perpetual and dated futures is less important than whether one is facing a proper clearing house with a mutualized default fund or an exchange that socializes losses onto winners. Krenn offered an insight that challenges the common assumption about perp risk, stating that being long is the structurally safer side. His logic is that positive funding is easy to arbitrage away, but when the funding rate is negative, the arbitrage involving a long position in the perp and a short position in the spot is more difficult, especially if the circulating supply is small and concentrated. This means that funding rates can persist at extremely negative levels for a long time. 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 often not accounted for in risk models. Krenn cited the example of lending protocol Euler's token, where funding on the perp went deeply negative, and shorts were 'paying in the region of one percent every four hours' to longs, with almost nobody able to compress it due to the small and concentrated float. In conclusion, perps have democratized futures trading by addressing issues of access, cost, and margin efficiency, but they also come with unique challenges, notably 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.' For now, funding is the tax everyone pays for easy access to this leveraged market.