The Dominance of Perpetual Futures in Crypto Markets

The process of determining crypto prices is often misunderstood, with many believing it to be driven by spot trading. However, perpetual futures, also known as perpetual swaps or 'perps,' have become the dominant force in crypto markets, accounting for roughly 93% of all crypto futures volume. These contracts, which never expire, allow traders to speculate on the price of an asset without actually owning it. Research has shown that perps are the primary source of price formation in the crypto market, with spot exchanges reacting to moves in the derivatives market rather than leading them. A study in the Journal of Financial Markets found that perpetual swaps on unregulated venues were the strongest instruments for bitcoin price discovery. The evidence suggests that the derivatives market is where prices are made, with spot markets following. The influence of perps was recently demonstrated in the valuation of SpaceX ahead of its IPO, where perpetual futures contracts accurately predicted the company's first-day trading price. However, the perp market's inability to account for supply-side factors, such as the release of locked-up insider shares, led to a significant decline in the stock's price. This highlights the importance of understanding the role of perps in price discovery and their limitations in accounting for all market factors.