Perpetual Futures Dominate Crypto Markets, Even Predicting SpaceX's IPO Price

The process of setting crypto prices is often misunderstood, with many believing it involves spot trading, where buyers and sellers meet on an exchange. However, perpetual futures, also known as perpetual swaps or 'perps,' have become the primary driver of price discovery in the crypto market, accounting for around 93% of all crypto futures volume. These contracts, which never expire, allow traders to leverage their positions and have been shown to lead price movements in the market. Research has consistently pointed to derivatives, particularly perpetual swaps on unregulated venues, as the strongest instruments for bitcoin price discovery, with regulated futures and US spot exchanges reacting to these moves. A study found that Binance's perpetual market is the primary source 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 direction of the literature has been toward the derivatives market as the primary price discovery mechanism. The funding rate, which is the cost of holding a perpetual contract, plays a crucial role in keeping the contract price anchored to the underlying spot price and serves as a live readout of market sentiment. Traders closely watch the funding rate, as it provides insight into market sentiment and can indicate potential price movements. The recent example of SpaceX's IPO, where perpetual futures contracts accurately predicted the company's stock price, demonstrates the influence of perps in the market. Traders on various exchanges, including Binance and Coinbase, were buying and selling exposure to SpaceX through pre-IPO perpetual futures, which were structured to track an implied valuation rather than a share price. The perpetuals on Hyperliquid and Binance were quoting the equivalent of roughly $170 a share, well above the $135 IPO price set by underwriters. On the day of the IPO, the stock opened at $161, up 19% from the IPO price, and the perpetual market had accurately priced the demand for the stock. However, the perpetual market is blind to supply, and the subsequent fall in the stock price was due to the release of locked-up insider shares, which was not priced into the perpetual contracts. This example highlights the importance of understanding the role of perpetual futures in the crypto market and their influence on price discovery.