The Double-Edged Nature 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 larger positions with less capital. Perps function similarly to standard futures but without an expiration date. For traders of alternative cryptocurrencies, perps are often 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 the needs of both institutional and retail traders, and the associated costs. The traders unanimously praised perps for their deep liquidity, low trading fees, and efficient margin usage. However, they also expressed concern over the funding rates, which are recurring costs for maintaining open positions. Funding rates are essentially interest charges that accumulate over time and can significantly add up. The high daily volume of over $200 billion in crypto perps is attributed to necessity rather than choice. According to Lucas Krenn, a derivatives trader, perps are the primary tool for crypto-native firms due to the lack of liquidity in dated futures outside of bitcoin and ether. Krenn explained that dated futures are less popular because they require replacement with new contracts at expiry, incurring additional costs. Perps, on the other hand, offer better fills, lower fees, and the ability to hold both long and short positions simultaneously. Kenneth Ong, an independent trader, shared a similar perspective, highlighting the advantages of perps for retail traders, including hedge mode, which allows for holding both bullish and bearish bets on the same token. The traders emphasized that margin efficiency is a significant draw to perps, enabling them to manage risk efficiently across different venues and tokens. Because perps require only a fraction of the position's value as collateral, traders can split their capital across multiple venues and maintain meaningful positions. The always-on nature of perps has 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, and by Monday, the repricing had already occurred. Krenn noted that perps tied to traditional assets are also gaining traction, as they sidestep the need for recreating the legal, operational, and regulatory machinery of traditional ownership on-chain. Both traders foresee the 'perpification' of various assets gaining momentum, with Ong stating that tokenized oil trading is a preview of what's to come for other commodities. However, they also warned about the funding rate, which can be a significant concern for traders. 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. This exposes traders to a floating rate while holding the position, with no mechanism to lock it in. Krenn described the funding rate as 'unquantifiable at the point of trade and unhedgeable afterwards.' Ong expressed his concern more bluntly, stating that the funding rate can potentially turn a profitable trade into a loss if held for an extended period. The traders also addressed the issue of liquidations, which are often cited as a problem with perps. However, Krenn argued that the issue lies with the crypto exchange margin model, not with perps themselves. He emphasized that the distinction between perpetual and dated futures is not the primary concern, but rather whether the exchange has a proper clearing house with a mutualized default fund. Krenn offered an insight that inverts the common assumption about perp risk, stating that being long is the structurally safer side. His logic is that positive funding is easy to arbitrage away, but negative funding is more challenging to address due to the difficulty of shorting the underlying token. This asymmetry is often overlooked in risk models. In conclusion, while perps have democratized futures trading by solving 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, the whole market is carrying an interest rate exposure that it cannot price or hedge, making funding the 'tax' everyone pays for easy access to this leveraged market.