The Dominance of Perpetual Futures in Crypto Markets

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, for years, perpetual futures, also known as perpetual swaps or 'perps,' have been the primary drivers of price discovery in the crypto market, accounting for approximately 93% of all crypto futures volume. Perps are leverage-friendly contracts that never expire and can be held indefinitely by paying a daily funding rate. Research has shown that perps 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. The funding rate, which is the cost of holding a perp, is a key factor in price discovery, as it reflects the sentiment of traders and keeps the contract price anchored to the underlying asset. A recent example of the influence of perps can be seen in the case of SpaceX's initial public offering, where traders on Binance, Coinbase, and other platforms were buying and selling exposure to the company through pre-IPO perpetual futures. The perpetual market accurately predicted the first-day demand for SpaceX's stock, with the price opening at $161, up 19% from the IPO price of $135. This example highlights the dominance of perps in price discovery, even in the private sector. However, perps are not perfect and can be blind to supply, as seen in the case of SpaceX's stock, which has fallen over 40% from its peak due to the release of locked-up insider shares.