The Dominance of Perpetual Futures in Shaping Bitcoin and Ether Markets

The process of setting crypto prices is often misunderstood, with many believing it occurs through spot trading on exchanges. However, perpetual futures, also known as perpetual swaps or 'perps,' have become the dominant force in shaping bitcoin, ether, and broader crypto market prices. These contracts, which never expire, account for approximately 93% of all crypto futures volume, surpassing the daily spot market volume. Perps allow traders to hold positions indefinitely by paying a funding rate, which varies daily. Research has shown that perpetual swaps on unregulated venues are the strongest instruments for bitcoin price discovery, with regulated futures and US spot exchanges reacting to these moves. A study published in the Journal of Financial Markets found that perpetual swaps were the primary source of price formation for bitcoin. Other research has identified Binance's perpetual market as the main driver of price formation across the fragmented crypto landscape. While the evidence is not conclusive, and some studies suggest spot markets still lead at certain frequencies or during times of stress, the overall trend points to derivatives markets as the primary price discovery mechanism. The funding rate, which is both a tether to the underlying price and a sentiment indicator, is closely watched by traders. The use of perpetual futures to predict the valuation of private companies like SpaceX has demonstrated their accuracy, even when traditional markets are not available. In the case of SpaceX, perpetual futures contracts were traded on various exchanges before the company's initial public offering, and their prices closely matched the eventual opening price of the stock. This example highlights the growing influence of derivatives markets in shaping prices, not only in the crypto space but also in traditional markets.