The Dominance of Perpetual Futures in Shaping Bitcoin and Ether Prices

The process of setting crypto prices is often misunderstood, with many believing it involves spot trading on exchanges. However, perpetual futures, also known as perpetual swaps or 'perps,' have become the primary mechanism for price discovery in the crypto market, accounting for approximately 93% of all crypto futures volume. These contracts, which never expire, allow traders to buy and sell exposure to an asset with leverage, and their prices are influenced by a funding rate that 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. The evidence suggests that the derivatives market, particularly perpetual futures, plays a significant role in shaping the prices of bitcoin and ether. A study by Carol Alexander and co-authors found that perpetual swaps on unregulated venues were the primary source of price discovery for bitcoin, while other work has identified Binance's perpetual market as the primary source of price formation across the crypto landscape. The funding rate, which is the cost of holding a perpetual contract, is both a tether that keeps the contract anchored to the underlying price and a live readout of market sentiment. Traders watch the funding rate closely, as it provides insight into the market's direction. The use of perpetual futures contracts to predict the IPO price of SpaceX is a notable example of their influence. Traders on Binance, Coinbase, and other platforms were able to buy and sell exposure to SpaceX through pre-IPO perpetual futures, which accurately predicted the company's IPO price. The perpetual market was pricing SpaceX well above the $135 IPO price, allowing traders to profit from the gap between the perp and the eventual opening price. However, the perpetual market is blind to supply, which can lead to price discrepancies. The case of SpaceX, where the stock price fell significantly after the IPO due to supply issues, highlights the importance of considering both demand and supply when evaluating market prices. In conclusion, perpetual futures have become a dominant force in shaping the prices of bitcoin and ether, and their influence extends to private companies like SpaceX. Understanding the role of perpetual futures and the funding rate is essential for navigating the crypto market and making informed investment decisions.