The Dual 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. Perps function similarly to standard futures but without an expiry date. 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 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 associated costs of perps trading. The traders' responses were clear and almost unanimous: everyone appreciates perps due to their deep liquidity, low trading fees, and efficient margin usage, which enables traders to gain significant exposure with minimal collateral. However, trading fees are not the only expense for traders; there's also a recurring cost for maintaining open positions, known as funding rates, which can accumulate over time. Traders are concerned about the impact of these funding rates. The reason perps are so popular, with daily volumes exceeding $200 billion, is not a matter of choice but necessity, according to Lucas Krenn, a derivatives trader at STS Digital. For crypto-native firms, perps are the primary tool, as dated futures for assets other than bitcoin and ether have limited liquidity, making them impractical. The process of replacing dated futures contracts at expiry is costly, which is why futures-based ETFs are often less efficient than spot ETFs. Liquidity refers to the market's ability to absorb large buy and sell orders without significantly affecting prices. According to Krenn, standard dated futures lack liquidity, making them susceptible to price swings from large orders, which increases slippage and negatively impacts traders. Kenneth Ong, an independent trader, explained the appeal of perps from a retail trader's perspective, highlighting better order fills, lower fees, and the ability to hold both long and short positions simultaneously via hedge mode. This is a significant advantage over regulated venues like the CME, where accounts are typically netted by default. Ong initially traded in the spot market but shifted to perps after realizing their benefits. For him, the spot market is now primarily for long-term holdings. Both Ong and Krenn emphasized that margin efficiency is the primary draw to perps. Since perps are the only real venue for trading most tokens, their leverage helps manage risk efficiently across different venues and tokens. Because perps require only a fraction of the position's value as collateral, the same capital can be split across multiple venues, supporting meaningful positions at each one. The perpetual nature of perps has changed how price discovery occurs, as it happens whenever news breaks, not just during market hours. Ong experienced this during the Iran conflict, where tokenized oil trading saw a significant surge in volume over a weekend, and by Monday, much of the price adjustment had already occurred. Krenn sees a similar mechanism at play in perps tied to traditional assets. Building tokenized equity products is challenging due to the need to recreate the legal, operational, and regulatory framework of traditional share ownership on-chain. Perps that reference the price can sidestep these issues, making them appealing for those looking to trade rather than invest long-term. Both traders believe the 'perpification' of various assets will gain momentum, with Ong suggesting that tokenized oil trading is a preview of what's to come for other commodities. Increasing liquidity across commodities and equities could make dated futures less relevant. However, traders must beware of the funding rate, which can be a significant concern. 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 leaves traders exposed to a floating rate with no mechanism to lock it in, and if the market doesn't move as expected, the funding rate can become a burden. Krenn and Ong expressed concern over the funding rate, with Ong noting that it's not a negligible fee and can potentially turn a profitable trade into a loss if held for an extended period. The issue of funding rates is complex, and traders often underestimate its impact. Krenn pointed out that being long is structurally safer because positive funding is easy to arbitrage away, but negative funding is more challenging to address due to the difficulty in shorting the underlying token, especially if the circulating supply is small and concentrated. This asymmetry is not well-represented in most risk models, according to Krenn. He cited the example of Euler's token, where funding on the perp went deeply negative, and shorts were paying a significant amount every four hours to longs, with almost no one able to compress it due to the small and concentrated float. The takeaway is that while perps have democratized futures trading by addressing issues of access, cost, and margin efficiency, they come with unique challenges, notably 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 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.