The Double-Edged Nature 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 allow traders to control large positions with minimal capital. Unlike standard futures, perps have no expiration date, making them a popular choice among traders. For altcoin traders, perps are often the only viable option for derivatives trading, as dated futures for these coins are typically illiquid. Spot markets are also less desirable for short-term traders who don't plan to hold their positions long-term. To understand what makes perps unique, CoinDesk spoke with traders who have thrived in the perpetual futures market. They explained how perps help both institutional and retail traders manage their needs efficiently. The traders' responses were unanimous: perps are beloved for their deep liquidity, low trading fees, and high margin efficiency. However, trading fees are not the only expense traders need to consider. Funding rates, which can be thought of as interest charges, are a recurring cost for keeping positions open. Traders are concerned about how these rates can add up over time. So, why do traders prefer perps? According to Lucas Krenn, a derivatives trader at STS Digital, perps are the foundation of his firm's trading activities. 'Outside of bitcoin and ether, dated futures liquidity is thin to the point of being unusable,' he said. 'Perps are not just one tool among many; for a crypto-native firm, they are the primary tool.' Dated futures are less popular due to the costs associated with replacing them at expiration. This is also why futures-based ETFs tend to be less efficient than spot ETFs. Perps offer better liquidity, allowing traders to absorb large buy and sell orders at stable prices. Independent trader Kenneth Ong explained that perps provide better fills, lower fees, and the ability to run both long and short positions simultaneously via hedge mode. This is a significant advantage over regulated venues like CME, which typically net positions by default. Ong started trading in the spot market but shifted to perps due to their benefits. For him, spot trading is now mainly for long-term holdings. Both Ong and Krenn emphasized that margin efficiency is the primary draw to perps. With perps, traders can manage risk efficiently across different venues and tokens, as they require only a fraction of the position's value as collateral. The perpetual nature of perps has also shifted price discovery to occur around the clock, rather than just during market hours. Ong experienced this during the Iran conflict, where tokenized oil trading on Hyperliquid saw a surge in volume over a weekend. By Monday, a significant portion of the repricing had already occurred. Krenn sees the same mechanism playing out in perps tied to other traditional assets. Building a proper tokenized equity product is challenging, but perps can sidestep these issues, making them attractive for traders. Both traders believe that the 'perpification' of various assets will gain momentum in the coming years. Ong noted that tokenized oil trading over the weekend is a preview of what's to come for other commodities. However, traders also warned about the funding rate, which can be a significant burden if not managed properly. A dated futures contract provides a fixed interest rate, whereas a perpetual futures contract has a funding rate that changes over time. This exposes traders to a floating rate while holding the position, with no built-in mechanism to lock it in. If the market doesn't move as expected, the funding rate can become a significant cost. Krenn described it as 'unquantifiable at the point of trade and unhedgeable afterwards.' Ong was more blunt, stating that the funding rate 'is not just some tiny fee you can ignore. It's not. If you hold positions for long periods, it can potentially balloon to the point where a profitable trade loses money.' The recent bitcoin bear market highlighted the risks associated with perps. On October 10, exchanges socialized losses to protect their systems, resulting in widespread deleveraging across both losing and profitable positions. However, Krenn argued that the issue was not with perps themselves, but rather with the crypto exchange margin model. The distinction that matters is not between perpetual and dated futures, but rather whether traders are facing a proper clearing house with a mutualized default fund or an exchange that socializes losses onto winners. Krenn also offered an insight that challenges common assumptions about perp risk. He argued 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 becomes more difficult, and the gap between perp and spot prices can persist. This means that funding rates can stay extremely negative for long stretches. As a result, the long side has a bounded cost and an unbounded upside, while the short side has a bounded upside and an unbounded cost. This asymmetry is not accounted for in many risk models. In conclusion, perps have democratized futures trading by solving issues of access, cost, and margin efficiency. However, they also come with unique challenges, such as 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.' For now, funding is the tax everyone pays for easy access to this leveraged market.