The Dominance of Perpetual Futures in Crypto Markets

The mechanism behind cryptocurrency price setting is often misunderstood, with many believing it is driven by spot trading. However, the reality is that perpetual futures, also known as perps, have become the dominant force in the crypto market, accounting for approximately 93% of all crypto futures volume. These contracts, which can be held indefinitely, have been shown to lead price discovery, with research indicating that they are the primary source of new information in the market. A study by Carol Alexander and co-authors found that perpetual swaps on unregulated venues were the strongest instruments for bitcoin price discovery, with regulated futures and US spot exchanges reacting to, rather than leading, these moves. The evidence suggests that the derivatives market is where prices are made, with spot markets following. This phenomenon was exemplified in the case of SpaceX, where perpetual futures contracts accurately predicted the company's IPO price, outperforming traditional Wall Street predictions. The funding rate, which is the cost of holding a perpetual contract, plays a crucial role in maintaining the contract's price and is closely watched by traders as a sentiment indicator. However, it is essential to note that perpetual futures are excellent at pricing demand but blind to supply, which can lead to significant price movements when supply factors are introduced. The influence of perps is not limited to crypto markets, as demonstrated by the SpaceX example, where they accurately predicted the company's IPO price. As the crypto market continues to evolve, it is likely that perpetual futures will remain a dominant force in price discovery, with spot markets playing a secondary role.