The Dominance of Perpetual Futures in Bitcoin and Ether 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 perps, have become the dominant force in the crypto market, accounting for approximately 93% of all crypto futures volume. These contracts, which never expire, allow traders to buy and sell with leverage, and their prices are influenced by funding rates, which can vary daily. Research has shown that perpetual swaps 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. A study found that Binance's perpetual market is the primary source of price formation across the fragmented crypto landscape. The evidence is not conclusive, but the direction of the literature suggests that the derivatives market is where prices are made. Historically, perps have led price rallies during bear markets, with spot demand contracting while perps demand expanded. The funding rate, which is paid by the crowded side of the trade every few hours, is a live readout of sentiment and keeps the contract anchored to the underlying price. Traders watch the funding rate closely, as it can indicate the direction of the market. In the case of SpaceX, pre-IPO perpetual futures contracts were traded on various exchanges, including Binance, Coinbase, and Hyperliquid, with prices quoting above the eventual IPO price. The accuracy of these contracts in predicting the first-day demand was impressive, with the stock price printing almost exactly where the perps had it. However, the perpetual market was blind to the supply side, which ultimately led to a significant drop in the stock price. This example illustrates the dominance of perpetual futures in price discovery, with spot markets following their lead.