The Double-Edged Sword of Perpetual Futures in Crypto Trading

When discussing crypto trading with experienced traders, the conversation often revolves around perpetual futures, or 'perps'. These derivatives contracts enable traders to control larger positions than the money held in their account, without an expiry date. Perps function similarly to standard futures but offer the advantage of no expiration. For traders of alternative cryptocurrencies, perps are often the only available avenue for derivatives trading, as dated futures for these coins are typically illiquid and the spot market is not a viable option for those who don't plan to hold. CoinDesk spoke with traders who have thrived in the perpetual futures market to understand what sets perps apart from other derivatives, how they cater to the needs of both institutional and retail traders, and the costs associated with perps trading. The traders' responses were unanimous: everyone loves perps due to their deep liquidity, low trading fees, and efficient margin usage, which refers to the amount of trading exposure one can get per unit of collateral posted. However, trading fees are not the only expense for traders, as there is also a recurring cost for maintaining open positions, known as funding rates. This can be thought of as an interest charge that accumulates over time, and the traders expressed concern about the potential impact of these rates. So, why do perps average a daily volume of over $200 billion? Traders attribute this to necessity rather than choice. Lucas Krenn, a derivatives trader at market-making firm STS Digital, stated that perps are the foundation of everything his firm does, particularly for cryptocurrencies outside of bitcoin and ether, where dated futures liquidity is scarce. Dated futures are not popular because they need to be replaced with new contracts at expiry, which incurs costs, making futures-based ETFs less efficient than spot ETFs. Perps offer better liquidity, allowing for large buy and sell orders at stable prices, whereas standard dated futures are often illiquid, making them susceptible to price swings. Kenneth Ong, an independent trader, explained that perps provide retail traders with better fills, lower fees, and the ability to hold both long and short positions on the same token simultaneously. This is a significant advantage over regulated venues like CME, which typically net positions by default. Ong and Krenn both emphasized that margin efficiency is the primary draw to perps, as they require only a fraction of the position's value as collateral, enabling traders to split their capital across multiple venues and tokens. The perpetual nature of perps has also shifted price discovery to occur whenever news breaks, rather than only during market hours. Ong shared an experience during the Iran conflict, where tokenized oil trading on Hyperliquid saw a surge in volume over a weekend, with the bulk of the price reaction happening on crypto/tokenized commodity perps while traditional markets were closed. Krenn sees this mechanism playing out in perps tied to other traditional assets, such as tokenized equities, which can sidestep the need for recreating the full legal and regulatory framework of traditional share ownership on-chain. Both traders believe that the 'perpification' of various assets will gain momentum in the coming years, with Ong stating that tokenized oil trading over weekends is a preview of what's to come for other commodities. However, they also warned about the funding rate, which can be a significant burden for traders, particularly if the market doesn't move as expected. A dated futures contract provides a clear interest rate from the outset, whereas a perpetual futures contract has a funding rate that changes over time, typically charged every eight hours, leaving the trader exposed to a floating rate with no built-in mechanism to lock it in. Krenn and Ong expressed concern over the funding rate, with Ong stating that it's not a minor fee and can potentially turn a profitable trade into a loss if held for an extended period. The traders also discussed the myth of the safe trade, citing the October 10 crash, which triggered widespread deleveraging across both losing and profitable positions. Krenn argued that the problem lies not with perps but with the crypto exchange margin model, which socializes losses onto winners. He emphasized that the distinction between perpetual and dated futures is not the primary concern, but rather whether one is facing a proper clearing house with a mutualized default fund or an exchange that socializes losses. Krenn offered an insight that inverts the common assumption about perp risk, stating 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 involving a long position in the perp and a short position in the spot is more challenging, allowing the gap between perp and spot prices to persist. This asymmetry, where the long side has a bounded cost and an unbounded upside, while the short side has a bounded upside and an unbounded cost, is not accounted for in many risk models. Krenn pointed to the example of lending protocol Euler's token, where a hard run on a listing led to a small and concentrated float, with funding on the perp going deeply negative and shorts paying a significant amount to longs. The takeaway is that perps have democratized futures trading by solving the problems of access, cost, and margin efficiency, but they are not without unique challenges, particularly the volatile funding-rate exposure that cannot be quantified or hedged. 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 or hedge, and funding is the tax everyone pays for easy access to this leveraged market.