The Dual Nature of Perpetual Futures in Crypto Trading: Benefits and Drawbacks

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 larger positions with less capital, functioning similarly to standard futures but without an expiry date. For traders of alternative cryptocurrencies, perps may be the only viable option for derivatives trading due to the illiquidity of dated futures and the spot market. CoinDesk spoke with traders who have thrived in the perpetual futures market to understand what sets perps apart, how they cater to both institutional and retail traders, and the costs associated with perps trading. The traders unanimously praised perps for their deep liquidity, cheap trading fees, and efficient margin use, which enables significant trading exposure with minimal collateral. However, they also expressed concerns about the funding rates, a recurring cost for maintaining open positions, likening it to an interest charge that accumulates over time. The reason for the popularity of perps, with daily volumes exceeding $200 billion, is attributed to necessity rather than choice. Lucas Krenn, a derivatives trader at STS Digital, and Kenneth Ong, an independent trader, both emphasized that perps are not just one tool among many but the primary tool for crypto-native firms and retail traders alike. This is because dated futures suffer from thin liquidity, leading to significant costs when replacing contracts at expiry, a issue that also affects futures-based ETFs. Perps offer better fills, lower fees, and the ability to hold both long and short positions simultaneously via hedge mode, a feature not available in regulated venues like the CME. The traders highlighted margin efficiency as a key advantage of perps, allowing for the management of risk across different venues and tokens with greater leverage than standard futures. The perpetual nature of perps has also shifted price discovery to occur around the clock, rather than just during market hours. This was exemplified during the Iran conflict, where tokenized oil trading on Hyperliquid saw a surge in volume over a weekend, with the 'official' market closed. The traders foresee the 'perpification' of various assets gaining momentum, with tokenized oil trading being a preview of what's to come for other commodities and equities. However, they cautioned about the funding rate, which can become a significant burden if not properly managed, especially for long-term positions. Unlike dated futures contracts, which have a fixed interest rate, perps have a funding rate that changes over time, typically charged every eight hours, leaving traders exposed to a floating rate without a built-in mechanism to lock it in. The funding rate can potentially negate the profitability of a trade if the market doesn't move as expected. Krenn and Ong warned that this funding rate is not just a minor fee but can balloon over time, especially for long positions. They also addressed the criticism of perps following the October 10 crash, which triggered widespread deleveraging, arguing that the issue lies with the crypto exchange margin model rather than perps themselves. Krenn pointed out that the distinction between perpetual and dated futures is not the key issue; rather, it's whether the exchange has a proper clearing house with a mutualized default fund. He also offered an insight that inverts the common perception of perp risk, suggesting that being long is structurally safer due to the ease of arbitraging away positive funding. However, when the funding rate is negative, arbitrage is more difficult, leading to a persistent gap between perp and spot prices. This asymmetry, where the long side has a bounded cost and unbounded upside, while the short side has a bounded upside and unbounded cost, is rarely accounted for in risk models. In conclusion, while perps have democratized futures trading by addressing issues of access, cost, and margin efficiency, they are not without their unique challenges, particularly the volatile funding-rate exposure that cannot be quantified or hedged.