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, perpetual futures, also known as perpetual swaps or 'perps,' have become the primary drivers of price discovery for bitcoin, ether, and the broader crypto market, accounting for roughly 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. Studies have shown that perpetual swaps on unregulated venues are the strongest instruments for bitcoin price discovery, with regulated futures and U.S. 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 perpetual contract, is a crucial component of this process, as it keeps the contract price anchored to the underlying asset and provides a live readout of market sentiment. A recent example of the power of perpetual futures was seen in the pricing of SpaceX's initial public offering (IPO), where traders on Binance, Coinbase, and other platforms were able to accurately predict the company's valuation using pre-IPO perpetual futures. This demonstrates the ability of perpetual futures to price demand and predict market trends, even in the absence of a spot market. However, it is essential to note that perpetual futures are blind to supply, which can lead to price discrepancies. The SpaceX example highlights the importance of understanding the role of perpetual futures in price discovery and their potential to influence market trends.