The Dominance of Perpetual Futures in Crypto Markets: A Lesson from SpaceX

The process of setting crypto prices is often misunderstood, with many believing it is driven by spot trading. However, perpetual futures, also known as perps, have become the dominant force in the market, accounting for approximately 93% of all crypto futures volume. These contracts, which never expire, allow traders to buy and sell with leverage, and their prices are influenced by a funding rate that varies daily. Research has shown that perps are the primary source of price discovery in the crypto market, with spot exchanges reacting to changes in the derivatives market rather than leading them. A study by Carol Alexander and co-authors found that perpetual swaps on unregulated venues were the strongest instruments for bitcoin price discovery, while other work has identified Binance's perpetual market as the primary source of price formation. The evidence is not conclusive, but the majority of research suggests that the derivatives market is where prices are made. The funding rate, which is paid by the crowded side of the trade every few hours, acts as a tether that keeps the contract price anchored to the underlying spot price and provides a live readout of market sentiment. Traders watch the funding rate closely, as it can indicate the direction of the market. The use of perps in pricing the valuation of companies like SpaceX has also been successful, with traders on Binance, Coinbase, and other platforms buying and selling exposure to the company through pre-IPO perpetual futures. The accuracy of these contracts in predicting the company's valuation was impressive, with the perpetual market pricing SpaceX well above the $135 IPO price. The gap between the perp price and the eventual opening price provided a trading opportunity, but the market's inability to price supply meant that the stock price eventually fell. The experience with SpaceX highlights the importance of the derivatives market in price discovery and the potential for perps to be used in a variety of applications beyond crypto trading.