The Double-Edged Sword of Perpetual Futures in Crypto Trading

When discussing crypto trading with experienced traders, the topic of perpetual futures, or 'perps,' often comes up. These derivatives contracts allow traders to control large positions with minimal capital. Perps function similarly to standard futures but lack an expiry date. For traders of alternative cryptocurrencies, perps are frequently the only available derivatives option, as dated futures for these assets are often illiquid. The spot market is also less relevant for traders who don't plan to hold their positions long-term. CoinDesk spoke with traders who have thrived in the perpetual futures market to understand what sets perps apart from other derivatives and how they meet the needs of both institutional and retail traders. The traders' responses highlighted the deep liquidity, low trading fees, and efficient margin usage of perps. However, they also expressed concerns about funding rates, which are recurring costs associated with keeping positions open. Funding rates can be thought of as interest charges that accumulate over time. The traders noted that while perps offer many benefits, the funding rates can add up significantly. So, why do traders prefer perps? According to Lucas Krenn, a derivatives trader at STS Digital, perps are the primary tool for crypto-native firms, as dated futures lack liquidity outside of bitcoin and ether. Krenn explained that dated futures are less popular due to the costs associated with replacing them at expiry, which also affects the efficiency of futures-based ETFs. Kenneth Ong, an independent trader, shared a similar perspective, stating that perps offer better fills, lower fees, and the ability to run both long and short positions simultaneously. Ong started trading in the spot market but shifted to perps due to their advantages. Both Krenn and Ong emphasized that margin efficiency is a significant draw for perps, allowing traders to manage risk efficiently across different venues and tokens. Perps require only a fraction of a position's value as collateral, enabling traders to split their capital across multiple venues and maintain meaningful positions. The perpetual nature of perps has also changed the way price discovery occurs, with news and events driving price movements at any time, rather than only during traditional 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 traditional markets opened, a significant portion of the price adjustment had already occurred. Krenn noted that perps tied to traditional assets, such as tokenized equities, can sidestep the complexity of recreating traditional share ownership on-chain. This makes perps an attractive option for traders. However, the traders also warned about the risks associated with perps, particularly the funding rate. A dated futures contract provides a clear interest rate, 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, which can become a burden if the market doesn't move as expected. Krenn and Ong expressed concerns that the funding rate can be unquantifiable and unhedgeable, potentially leading to significant losses. The traders also discussed the myth of the 'safe trade,' highlighting an instance where a market crash triggered widespread deleveraging, resulting in the forced closure of both losing and profitable positions. Krenn argued that the issue was not with perps themselves but rather with the crypto exchange margin model. He emphasized that the key distinction is between facing a proper clearing house with a mutualized default fund and an exchange that socializes losses onto winners. Krenn also offered an insight that challenges common assumptions about perp risk, stating that being long is structurally safer due to the ease of arbitraging away positive funding. However, when the funding rate is negative, the arbitrage becomes more difficult, and the gap between perp and spot prices can persist. This asymmetry is often overlooked in risk models. In conclusion, perps have democratized futures trading by addressing issues of access, cost, and margin efficiency. Nevertheless, they come with unique challenges, such as volatile funding-rate exposure. As Krenn put it, until a liquid dated curve emerges in crypto, the market will continue to carry an interest rate exposure that cannot be priced or hedged.