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 large positions with minimal capital. Unlike standard futures, perps do not have an expiration date, making them a unique and popular choice among traders. For altcoin traders, perps are often the only viable option for derivatives trading, as dated futures contracts for these assets are typically illiquid. The spot market is also not a preferred choice for traders who do not plan to hold onto their assets long-term. CoinDesk spoke with traders who have thrived in the perps market to understand what sets them apart from other derivatives and how they cater to the needs of both institutional and retail traders. The traders unanimously agreed that perps offer deep liquidity, low trading fees, and efficient margin usage, making them an attractive choice. However, they also expressed concerns about the funding rates associated with perps, which can add up over time and eat into traders' profits. So, why do traders prefer perps? According to Lucas Krenn, a derivatives trader at STS Digital, perps are the foundation of their trading strategy. '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 are not popular due to the costs associated with replacing them at expiration. This is also why futures-based ETFs are often less efficient than spot ETFs. Perps, on the other hand, offer better liquidity, allowing traders to execute large buy and sell orders at stable prices. Kenneth Ong, an independent trader, shared a similar perspective, highlighting the benefits of perps for retail traders. According to Ong, perps provide better fills, lower fees, and the ability to run both long and short positions simultaneously via hedge mode. This is a significant advantage over regulated venues like CME, which typically net positions by default. Ong started trading in the spot market but eventually shifted to perps due to their superior margin efficiency. Both Ong and Krenn emphasized that margin efficiency is the primary draw of perps. With perps, traders can manage risk efficiently across different venues and tokens, as they require only a fraction of the position's value as collateral. The perpetual nature of perps has also changed the way price discovery occurs. Instead of being limited to traditional market hours, price discovery now happens around the clock, whenever news breaks. Ong experienced this firsthand during the Iran conflict, where tokenized oil trading on Hyperliquid saw a significant surge in volume over a weekend. 'The real reaction happened on crypto/tokenized commodity perps while the official market was closed,' he said. Krenn sees the same mechanism playing out in perps tied to other traditional assets. For instance, building a tokenized equity product is challenging due to the need to recreate the legal, operational, and regulatory framework of traditional share ownership on-chain. Perps that reference the price of these assets sidestep these issues, making them an attractive choice for traders. Both traders believe that the 'perpification' of various assets will gain momentum in the coming years. Ong said 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 caveat: the funding rate. While many traders are concerned about liquidations, Krenn and Ong believe that the funding rate is a more significant issue. Unlike dated futures contracts, which have a fixed 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, which can become a burden if the market does not move as expected. 'It is unquantifiable at the point of trade and unhedgeable afterwards,' Krenn said. Ong was more blunt, stating that the funding rate is not a minor fee that can be ignored. 'If you hold positions for long periods, it can potentially balloon to the point where a profitable trade loses money,' he said. The funding rate can be particularly problematic during times of high market volatility. For example, during the October 10 crash last year, exchanges socialized losses to protect their systems, resulting in the liquidation of both losing and profitable positions. Krenn argued that this was not a problem with perps themselves but rather with the crypto exchange margin model. 'It is not a perpetual problem; it is a crypto exchange margin model problem,' he said. 'Dated futures on those same venues sit behind the same insurance funds and the same deleveraging queue.' Krenn also pointed out that the distinction between perpetual and dated futures is not as relevant as the difference between facing a proper clearing house with a mutualized default fund or an exchange that socializes losses onto winners. One insight that Krenn shared is that being long is often the structurally safer side of a trade. This is because positive funding is easy to arbitrage away, as anyone holding stablecoins can buy spot and sell the perp, compressing the spread. However, when the funding rate is negative, the arbitrage is more complex, involving a long position in the perp and a short position in the spot. This can be challenging, especially if the circulating supply of the underlying token is small and concentrated. As a result, the gap between perp and spot prices can persist, leading to extremely negative funding rates. 'The long side has a bounded cost and an unbounded upside,' Krenn explained. 'The short side has a bounded upside and an unbounded cost. That asymmetry sits in very few risk models.' In conclusion, perps have democratized futures trading by solving the problems of access, cost, and margin efficiency. However, they are not without unique challenges, particularly 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 that everyone pays for easy access to this leveraged market.