The Double-Edged Sword of Perpetual Futures: Benefits and Risks for Crypto Traders

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, offering a key advantage over standard futures: they never expire. For traders of alternative cryptocurrencies, perps are frequently the only viable option for derivatives trading, as dated futures for these assets are often illiquid, and the spot market is typically an afterthought for anyone not planning 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, highlighting their deep liquidity, low trading fees, and efficient margin usage, which allows for greater trading exposure with less collateral. However, they also expressed concerns over funding rates, a recurring cost for maintaining open positions that can add up over time. So, why do traders prefer perps? According to Lucas Krenn, a derivatives trader at STS Digital, perps are the foundation of their operations, particularly for assets beyond bitcoin and ether, where dated futures liquidity is scarce. Krenn explained that the process of replacing dated futures contracts at expiry is costly, making perps a more efficient choice. Kenneth Ong, an independent trader, shared a similar perspective, noting that perps offer better execution prices, lower fees, and the ability to hold both long and short positions simultaneously. This flexibility is a significant advantage over traditional futures markets, where positions are typically netted by default. Both Ong and Krenn emphasized that margin efficiency is a major draw for perps, as they require only a fraction of the position's value as collateral, allowing traders to manage risk more effectively across different venues and assets. The perpetual nature of perps has also shifted price discovery to a 24/7 process, with traders reacting to news and market developments in real-time, rather than only during traditional market hours. This has been particularly evident in the tokenized oil market, where perps have enabled traders to respond quickly to geopolitical events. Despite the benefits of perps, traders are wary of the funding rate, which can be a significant burden, especially for long-term positions. 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, making it challenging to quantify and hedge against. Krenn and Ong warned that the funding rate can potentially turn a profitable trade into a loss if not managed carefully. The traders also addressed the criticism that perps are inherently risky, citing the October 10 crash, which triggered widespread deleveraging across the crypto market. Krenn argued that the issue was not with perps themselves but rather with the crypto exchange margin model, which socializes losses onto winners. He emphasized that the key distinction 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. Krenn also offered an insightful perspective on the asymmetry of perp risk, suggesting that being long is structurally safer due to the ease of arbitraging away positive funding rates. However, when funding rates are negative, the arbitrage process is more complex, and the gap between perp and spot prices can persist, leading to extremely negative funding rates. In conclusion, while perps have democratized futures trading by providing access, low costs, and efficient margin usage, they also come with unique challenges, particularly the volatile funding-rate exposure that cannot be quantified or hedged. As Krenn noted, until a liquid dated curve emerges in crypto, the market will continue to carry an interest rate exposure that cannot be priced or hedged, making funding a 'tax' that everyone pays for access to this leveraged market.