Derivatives Markets Dominate Bitcoin and Ether Price Discovery

The mechanism of setting crypto prices has evolved, with perpetual futures, also known as perpetual swaps or 'perps', playing a significant role in bitcoin and ether price discovery. These contracts, which never expire, account for approximately 93% of all crypto futures volume, often surpassing the spot market. A study in the Journal of Financial Markets found that perpetual swaps on unregulated venues were the strongest instruments for bitcoin price discovery, with regulated futures and U.S. spot exchanges reacting to these moves. Other research has identified Binance's perpetual market as the primary source of price formation in the crypto landscape. Historically, perps have led price rallies, particularly during bear markets. The funding rate, which is the cost of holding a perpetual contract, is a key factor in price discovery, as it reflects market sentiment. The use of perpetual futures contracts to price pre-IPO companies, such as SpaceX, has also demonstrated their accuracy in predicting market prices. In the case of SpaceX, perpetual futures contracts priced the company's valuation more accurately than traditional underwriters. However, the derivatives market is not without its limitations, as it can be blind to supply-side factors, such as the release of locked-up insider shares. Overall, the research suggests that the derivatives market is increasingly where price discovery occurs, with spot markets following suit.