The Double-Edged Sword 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 enable traders to control larger positions with less capital, offering a key advantage over standard futures: they never expire. 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 mostly used for long-term holdings. 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 unanimously praised perps for their deep liquidity, low trading fees, and efficient margin usage. However, they also expressed concerns about funding rates, which are recurring costs for maintaining open positions. These rates can add up over time and are a significant expense for traders. So, why do traders prefer perps? According to Lucas Krenn, a derivatives trader at STS Digital, perps are the backbone of his firm's operations, particularly for assets other than bitcoin and ether, where dated futures liquidity is scarce. Krenn noted that dated futures are less popular due to the costs associated with replacing them at expiry, which also makes futures-based ETFs less efficient than spot ETFs. Kenneth Ong, an independent trader, shared a similar perspective, highlighting the benefits of perps for retail traders, including better order fills, lower fees, and the ability to hold both long and short positions simultaneously. Ong started trading in the spot market but shifted to perps due to their advantages. Both Krenn and Ong emphasized that margin efficiency is a significant draw for perps, as they require only a fraction of the position's value as collateral, allowing traders to split their capital across multiple venues and tokens. The perpetual nature of perps has also changed the dynamics of price discovery, which now occurs 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 significant surge in volume, with the majority of the price reaction happening on crypto and tokenized commodity perps while traditional markets were closed. Krenn sees this mechanism playing out in perps tied to other traditional assets, such as equities, where building a proper tokenized product is challenging due to regulatory and operational requirements. Perps that reference the price of these assets can sidestep these issues, making them an attractive option for traders. Both traders believe that the 'perpification' of various assets will gain momentum in the coming years, with Ong noting that tokenized oil trading is a preview of what's to come for other commodities. As liquidity deepens across commodities and equities, it will reduce the need for dated futures. However, there is a caveat: the funding rate. While liquidations are often cited as a concern for perps, Krenn and Ong believe that funding rates are a more significant issue. Unlike dated futures contracts, which have a fixed interest rate, perps have a funding rate that changes over time and is typically charged every eight hours. This exposes traders to a floating rate, which can become a burden if the market doesn't move as expected. Krenn described the funding rate as 'unquantifiable' at the point of trade and 'unhedgeable' afterwards. Ong was more blunt, 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 safe trades, citing the October 10 crash, which triggered widespread deleveraging across both losing and profitable positions. Krenn argued that the problem wasn't with perps but rather with the crypto exchange margin model. He noted that dated futures on the same venues face the same issues, and the key distinction is whether traders are facing a proper clearing house with a mutualized default fund or an exchange that socializes losses onto winners. Krenn offered an interesting insight into perp risk, suggesting that being long is the structurally safer side. His logic is that positive funding is easy to arbitrage away, but when the funding rate is negative, the arbitrage is more challenging, leading to a persistent gap between perp and spot prices. This means that funding rates can remain extremely negative for extended periods. In conclusion, perps have democratized futures trading by solving issues of access, cost, and margin efficiency. However, they come with unique challenges, particularly the volatile funding-rate exposure that can't 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.