The Double-Edged Sword of Perpetual Futures: Benefits and Risks for 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, and unlike standard futures, they have no expiration date. For traders of alternative cryptocurrencies, perps may be the only viable option for derivatives trading, as dated futures for these assets are often illiquid, and the spot market is not a priority for those who don't plan to hold onto their assets long-term. 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 overwhelmingly positive, citing the deep liquidity, low trading fees, and high margin efficiency of perps. However, they also expressed concerns about the funding rates, which are recurring costs for maintaining open positions. These funding rates can be thought of as interest charges that accrue over time, and traders are worried about their potential impact on their profits. So, why do traders prefer perps? According to Lucas Krenn, a derivatives trader at STS Digital, perps are the primary tool for crypto-native firms, as they offer a more efficient way to trade than dated futures. Krenn explained that dated futures are often illiquid, making it difficult to execute large trades without significantly affecting the market price. In contrast, perps provide 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 benefits of perps for retail traders, including better fills, lower fees, and the ability to hedge positions. Both Krenn and Ong emphasized that margin efficiency is a significant advantage of perps, allowing traders to manage risk more effectively across different venues and tokens. The perpetual nature of perps has also shifted the way price discovery occurs, with traders reacting to news and events in real-time, rather than waiting for traditional market hours. Ong recalled an instance during the Iran conflict, where tokenized oil trading on Hyperliquid saw a significant surge in volume, with much of the price reaction happening on crypto and tokenized commodity perps while traditional markets were closed. Krenn noted that perps tied to traditional assets, such as equities, can also provide a more efficient way to trade, as they sidestep the need to recreate the full legal, operational, and regulatory machinery of traditional ownership on-chain. However, both traders warned about the risks associated with perps, particularly the funding rates, which can be unpredictable and difficult to hedge. Krenn explained that funding rates can be a significant burden for traders, especially if they hold positions for extended periods. Ong was more blunt, stating that funding rates can potentially turn a profitable trade into a loss. The traders also discussed the myth of the 'safe trade,' highlighting an instance where exchanges socialized losses to protect their systems, resulting in the forced closure of both losing and profitable positions. Krenn argued that this was not a problem with perps themselves, but rather with the crypto exchange margin model. He emphasized that the key distinction is between facing a proper clearing house with a mutualized default fund and an exchange that socializes losses onto winners. Krenn also offered an insight that challenges the common assumption about perp risk, suggesting that being long is the structurally safer side. He explained that positive funding is easy to arbitrage away, but negative funding can be more difficult to hedge, particularly if the circulating supply is small and concentrated. This asymmetry can lead to funding rates staying extremely negative for extended periods, making the long side have a bounded cost and an unbounded upside, while the short side has a bounded upside and an unbounded cost. In conclusion, perps have democratized futures trading by providing a solution to the problems of access, cost, and margin efficiency. However, 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 and cannot hedge.'