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. Unlike standard futures, perps have no expiration date, making them a popular choice among traders. For altcoin traders, perps are often the only viable option for derivatives trading, as dated futures for these assets are typically illiquid. The spot market is also less appealing for traders who don't plan to hold their positions long-term. To understand what makes perps unique, we spoke with traders who have thrived in this market. They highlighted the deep liquidity, low trading fees, and efficient margin usage as key advantages. However, they also expressed concerns over funding rates, which are recurring costs associated with keeping positions open. Funding rates can be thought of as interest charges that accumulate over time. Traders are worried about how these rates could add up and impact their profitability. So, why do traders prefer perps? The answer lies in their necessity, rather than choice. Lucas Krenn, a derivatives trader, explained that perps are the foundation of his firm's trading activities, particularly for assets outside of bitcoin and ether. Dated futures are often illiquid, making them less desirable. Perps, on the other hand, offer better fills, lower fees, and the ability to hold both long and short positions simultaneously. This is a significant advantage over regulated venues like the CME, which typically net positions by default. Kenneth Ong, an independent trader, shared a similar perspective, emphasizing the benefits of perps for retail traders. He noted that perps provide better fills, lower fees, and the ability to run both sides of a trade via hedge mode. Ong started trading in the spot market but eventually shifted to perps due to their advantages. Both Ong and Krenn stressed that margin efficiency is a major draw for perps. With perps, traders can manage risk more 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 shifted price discovery to occur around the clock, rather than just during market hours. Ong recalled an incident during the Iran conflict, where tokenized oil trading on Hyperliquid saw a significant surge in volume over a weekend. By Monday, a chunk of the repricing had already occurred, demonstrating how perps can facilitate price discovery outside of traditional market hours. Krenn sees this mechanism playing out in perps tied to other traditional assets, such as tokenized equities. Building a proper tokenized equity product is challenging, but perps can sidestep these complexities, making them an attractive option for traders. Both traders believe that the 'perpification' of various assets will gain momentum in the coming years. Ong noted 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 concern that needs to be addressed: the funding rate. While liquidations are often cited as a problem with perps, Krenn and Ong believe that funding rates are 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 exposes traders to a floating rate, 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 just a tiny fee, but can potentially balloon and turn a profitable trade into a loss. The issue of funding rates is further complicated by the fact that it's not just a perpetual problem, but also a crypto exchange margin model problem. Krenn noted that dated futures on the same venues sit behind the same insurance funds and deleveraging queues. The key distinction is whether you're facing a proper clearing house with a mutualized default fund or an exchange that socializes losses onto winners. Krenn offered an interesting insight into perp risk, inverting what most people assume. He believes that being long is the structurally safer side, as positive funding is easy to arbitrage away. However, when the funding rate is negative, the arbitrage becomes more difficult, and the gap between perp and spot prices can persist. This means that funding rates can stay extremely negative for long stretches. 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 not well-represented in most risk models. Krenn cited the example of lending protocol Euler's token, where funding on the perp went deeply negative, and shorts were paying a significant amount to longs. The takeaway is that perps have democratized futures trading by solving the problem of access, cost, and margin efficiency. However, they are not without unique pain points, particularly the volatile funding-rate exposure that can't be quantified while taking bets and can't be hedged once the trade is on. 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.