The Dominance of Perpetual Futures in Crypto Markets

The process of setting crypto prices is often misunderstood, with many believing it involves spot trading on exchanges. However, perpetual futures, also known as perpetual swaps or 'perps,' have become the dominant force in the crypto market, accounting for approximately 93% of all crypto futures volume. These contracts are leverage-friendly, never expire, and can be held indefinitely by paying a funding rate that 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, rather than leading, these moves. The evidence suggests that the derivatives market is where prices are made, with spot markets following. This phenomenon was recently demonstrated 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 serves as a live readout of market sentiment. While the funding rate is essential for traders, it can also eat into their profits if they hold directional positions for extended periods. The SpaceX example highlights the power of perpetual futures in pricing demand, but also their limitations in accounting for supply. As the crypto market continues to evolve, the influence of perpetual futures is likely to remain a significant factor in shaping prices.