The Dominance of Perpetual Futures in Crypto Markets and Beyond

The process of setting crypto prices is often misunderstood, with many believing it is driven by spot trading, where buyers and sellers meet on an exchange. However, for years, perpetual futures, also known as perpetual swaps or 'perps,' have played a much more significant role in determining prices for bitcoin, ether, and the broader crypto market. These contracts, which never expire and are highly leveraged, now account for approximately 93% of all crypto futures volume, with daily volumes often surpassing those of the underlying spot market. Unlike traditional futures contracts, which have a settlement date and are forced to meet the spot price of the underlying asset, perpetual futures can be held indefinitely, with traders paying a funding rate that varies daily. Research has shown that derivatives markets, particularly those offering perpetual swaps, are where new information enters the market first, leading to price discovery. Studies have found that perpetual swaps on unregulated venues are strong instruments for bitcoin price discovery, with regulated futures and U.S. spot exchanges reacting to moves initiated in the derivatives market. The evidence suggests that while spot markets may still lead at certain frequencies or during periods of stress, the derivatives market, especially perpetual futures, is increasingly where prices are made. This phenomenon is not limited to crypto markets, as demonstrated by the pricing of SpaceX's initial public offering (IPO). Before the company's shares began trading on the Nasdaq, traders on various platforms, including Binance, Coinbase, and Hyperliquid, were buying and selling exposure to SpaceX through pre-IPO perpetual futures contracts. These contracts, which tracked an implied valuation rather than a share price, accurately predicted the first-day trading price of SpaceX shares, outperforming the IPO price set by underwriters. The success of perpetual futures in predicting the SpaceX IPO price highlights their effectiveness in pricing demand but also their limitations in accounting for supply. As the derivatives market continues to grow in influence, understanding its role in price discovery and its potential blind spots is crucial for traders and investors alike.