The Dominance of Perpetual Futures in Shaping Bitcoin and Ether Markets

The process of setting crypto prices is often misunderstood, with many believing it is driven by spot trading. However, perpetual futures, also known as perpetual swaps or 'perps', have become the dominant force in shaping bitcoin, ether, and broader crypto markets. These contracts, which never expire, account for approximately 93% of all crypto futures volume, with daily perp volume often surpassing the spot market. A key difference between traditional futures contracts and perps is the absence of a settlement date, allowing perps to be held indefinitely. The funding rate, which varies daily, is the cost of holding a perp position. Research has consistently shown that derivatives markets, particularly perpetual swaps on unregulated venues, are the primary source of price discovery for bitcoin. A study by Carol Alexander and co-authors found that perpetual swaps were the strongest instruments for bitcoin price discovery, with regulated futures and US spot exchanges reacting to, rather than leading, these moves. Other work has identified Binance's perpetual market as the primary source of price formation across the fragmented crypto landscape. While the evidence is not conclusive, with some studies finding spot markets still lead at certain frequencies or during stress, the direction of the literature over the past few years has been toward the derivatives market as the place where prices are made. 'Historically, we have seen perps leading mostly during bear market price rallies,' said Julio Moreno, head of research at CryptoQuant. The funding rate plays a crucial role in keeping the perp price anchored to the underlying spot price. When the perp trades above spot, traders who are long pay those who are short, nudging the contract back toward the underlying price. The funding rate is also a live readout of sentiment, which is why some traders watch it closely. The recent SpaceX IPO provides a unique example of the power of perpetual futures in price discovery. Traders on Binance, Coinbase, and other platforms were buying and selling exposure to SpaceX through pre-IPO perpetual futures, which accurately predicted the company's first-day trading price. The perp market was pricing SpaceX well above the $135 IPO price, allowing traders to bet on the gap between the perp and the eventual opening price. However, the perp market is excellent at pricing demand but blind to supply, which is worth remembering in times of market volatility.