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 do not have an expiration date, making them a unique and attractive option for traders. For traders of altcoins, perps are often the only viable derivatives market, as dated futures for these tokens are typically illiquid. In contrast, the spot market is usually an afterthought for traders who don't plan to hold onto their assets long-term. To better understand the world of perps, CoinDesk spoke with traders who have thrived in this market. They explained 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 unanimously agreed that perps are popular due to their deep liquidity, low trading fees, and efficient margin usage, which enables traders to maximize their exposure while minimizing collateral. However, they also expressed concerns over funding rates, a recurring cost for maintaining open positions. Funding rates can be thought of as an interest charge that accumulates over time, and traders are worried about the potential impact on their profits. So, why do traders prefer perps? According to Lucas Krenn, a derivatives trader at STS Digital, perps are the foundation of his firm's 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 are not popular because they require replacing contracts at expiry, which incurs costs. These costs also make futures-based ETFs less efficient than spot ETFs. Another trader, Kenneth Ong, shared his perspective as a retail trader. He stated that perps offer better execution, lower fees, and the ability to hold both long and short positions simultaneously via hedge mode. Ong started trading in the spot market but eventually shifted to perps due to their advantages. Both Ong and Krenn emphasized that margin efficiency is a significant draw for 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 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, while traditional markets were closed. By the time markets reopened, a significant portion of the price adjustment had already occurred in the perps market. Krenn sees a similar mechanism at play in perps tied to other traditional assets, such as equities. He believes that building a proper tokenized equity product is challenging due to the need to recreate the legal, operational, and regulatory framework of traditional share ownership on-chain. Perps, on the other hand, offer a more straightforward solution for traders. Both traders expect the 'perpification' of various assets to gain momentum in the coming years. Ong noted that tokenized oil trading is a preview of what's to come for other commodities, and as liquidity deepens, it will become less necessary to use dated futures. However, traders also warned about the risks associated with perps, particularly the funding rate. A dated futures contract provides a clear interest rate from the start, whereas a perpetual futures contract has a funding rate that changes over time, 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 described the funding rate 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 discussed the myth of the safe trade, citing the example of the October 10 crash, which triggered widespread deleveraging across both losing and profitable positions. Krenn argued that the problem was not with perps but with the crypto exchange margin model. He emphasized that the key distinction is not between perpetual and dated futures but between facing a proper clearing house with a mutualized default fund and an exchange that socializes losses onto winners. Krenn offered an interesting insight into the asymmetry of perp risk, suggesting that being long is the structurally safer side. His logic is that positive funding is easy to arbitrage away, whereas negative funding is more challenging to address due to the difficulties in shorting the underlying token. This asymmetry is not adequately accounted for in most risk models. In conclusion, perps have democratized futures trading by providing access, low costs, and efficient margin usage. However, they also come with unique pain points, such as 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.