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 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 mostly used for long-term holdings. To better understand what makes perps unique and how they cater to the needs of both institutional and retail traders, we spoke with traders who have thrived in the perpetual futures market. They highlighted the deep liquidity, low trading fees, and efficient margin usage as primary reasons for their preference for perps. However, they also expressed concerns about the recurring costs associated with keeping positions open, particularly the funding rates, which can significantly add up over time. So, why do traders flock to perps? The answer lies in necessity rather than choice, with daily volumes exceeding $200 billion. According to Lucas Krenn, a derivatives trader at STS Digital, perps are the backbone of their operations, especially for assets other than Bitcoin and Ethereum, where dated futures liquidity is scarce. Krenn noted that the process of replacing dated futures contracts at expiry is costly, making perps a more efficient choice. Another trader, Kenneth Ong, echoed this sentiment, emphasizing the benefits of perps for retail traders, including better execution prices, lower fees, and the ability to hold both long and short positions simultaneously. Ong also highlighted the importance of margin efficiency, which allows traders to manage risk across different venues and tokens with greater ease. The perpetual nature of perps has also shifted the dynamics of price discovery, allowing it to occur around the clock, rather than being limited to traditional market hours. This was evident during the Iran conflict, where tokenized oil trading on Hyperliquid saw a significant surge in volume over a weekend, with much of the price reaction happening before traditional markets opened. Both Krenn and Ong see this 'perpification' of various assets gaining momentum, with Ong predicting that increased liquidity in commodities and equities will make dated futures less relevant. However, they also warned about the funding rate, which can be a significant burden for traders, especially those holding positions for extended periods. Unlike dated futures contracts, which have a fixed interest rate, perpetual futures contracts have a funding rate that changes over time and is typically charged every eight hours, leaving traders exposed to floating rates without a built-in mechanism to lock them in. Krenn described this as 'unquantifiable' and 'unhedgeable,' while Ong noted that it can potentially turn a profitable trade into a loss. The traders also addressed the criticism of perps following the October 10 crash, which triggered widespread deleveraging and liquidations. Krenn argued that the issue was not with perps themselves but 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 between facing a proper clearing house with a mutualized default fund or an exchange that socializes losses. Krenn also offered an insight that challenges common assumptions about perp risk, suggesting that being long is structurally safer due to the ease of arbitraging away positive funding. However, when funding rates are negative, arbitrage becomes more difficult, leading to a persistent gap between perp and spot prices. This asymmetry, Krenn noted, is often overlooked in risk models. In conclusion, while perps have democratized futures trading by addressing issues of access, cost, and margin efficiency, they are not without unique challenges, particularly the volatile funding-rate exposure that cannot be quantified or hedged. As Krenn put it, until a liquid dated curve emerges in crypto, the market will continue to carry an interest rate exposure that it cannot price or hedge, making funding a 'tax' that everyone pays for access to this leveraged market.