The Dominance of Perpetual Futures in Crypto and Traditional Markets

The process of setting crypto prices is often misunderstood, with many believing it is determined by spot trading. However, perpetual futures, also known as perpetual swaps or 'perps,' have become the primary drivers of price discovery for bitcoin, ether, and other cryptocurrencies. These contracts, which never expire, account for approximately 93% of all crypto futures volume and often have a higher daily volume than the spot market. Perpetual futures are leverage-friendly, allowing traders to hold positions indefinitely by paying a funding rate that varies daily. Research has shown that derivatives markets, particularly perpetual swaps on unregulated venues, are the strongest indicators of bitcoin price discovery. A study in the Journal of Financial Markets found that perpetual swaps led price movements, while regulated futures and U.S. spot exchanges reacted to these changes. Other studies have identified Binance's perpetual market as the primary source of price formation in the crypto market. While the evidence is not conclusive, and some studies suggest that spot markets still lead at certain frequencies or during times of stress, the overall trend suggests that derivatives markets are where prices are made. Historically, perpetual futures have led price rallies during bear markets, with demand growth in perps preceding price increases. The funding rate, which is paid by the crowded side of the trade every few hours, serves as a tether that keeps the contract price anchored to the underlying asset and provides a live readout of market sentiment. Traders closely watch the funding rate, as it can indicate the direction of the market. In the case of SpaceX's initial public offering (IPO), perpetual futures contracts were traded on various platforms, including Binance, Coinbase, and Hyperliquid, before the company's shares were listed on the Nasdaq. These contracts, which were structured to track an implied valuation rather than a share price, accurately predicted the first-day trading price of SpaceX's shares. The perpetual market priced SpaceX above the $135 IPO price, and traders could buy contracts before the listing and bet on the price difference. When SpaceX's shares began trading, the perpetual contracts automatically switched to track the real share price, allowing traders to profit from the price difference. However, the perpetual market's inability to account for supply led to a significant drop in SpaceX's share price after the IPO, as locked-up insider shares became eligible to sell. This example illustrates the dominance of perpetual futures in price discovery, even in traditional markets. The derivatives market's ability to price demand accurately, while being blind to supply, is a key factor in its influence on crypto and traditional markets.