Cryptocurrency Markets are Dominated by Perpetual Futures, as Evidenced by SpaceX's IPO

The process of setting cryptocurrency prices is often misunderstood, with many believing it is driven by spot trading, where buyers and sellers meet on an exchange. However, the reality is that perpetual futures, also known as perpetual swaps or 'perps', have become the primary driver of price discovery for bitcoin, ether, and other cryptocurrencies. These contracts, which never expire, account for roughly 93% of all crypto futures volume and often have a daily volume that exceeds the underlying spot market. A traditional futures contract has a settlement date when it comes due and its price is forced to meet the spot price of the underlying asset. In contrast, perpetual futures can be held indefinitely by paying a funding rate, which varies 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. One study found that Binance's perpetual market is the primary source of price formation across the fragmented crypto landscape. While the evidence is not conclusive, with some studies finding that spot markets still lead at certain frequencies or during times of stress, the overall trend in recent years has been towards the derivatives market as the primary driver of price discovery. The funding rate, which is paid by the crowded side of the trade every few hours, serves as a tether that keeps the contract anchored to the underlying price and provides a live readout of market sentiment. Traders closely watch the funding rate, as it provides valuable insights into market dynamics. The use of perpetual futures contracts is not limited to cryptocurrencies, as evidenced by the recent example of SpaceX's initial public offering (IPO). For several weeks, traders were able to buy and sell exposure to SpaceX through pre-IPO perpetual futures contracts on various exchanges, including Binance, Coinbase, and Hyperliquid. These contracts were structured to track an implied valuation rather than a share price. The striking aspect of this example is how accurately the perpetual futures market priced SpaceX's IPO, with the contracts quoting a price of around $170 per share, well above the $135 set by the underwriters. On the day of the IPO, the stock opened at $161, up 19% from the IPO price, and the perpetual futures market had accurately predicted this price. This example highlights the ability of perpetual futures markets to accurately price demand, but also their limitations in pricing supply. As the derivatives market continues to grow and evolve, it is likely to play an increasingly important role in driving price discovery for cryptocurrencies and other assets.