The Dominance of Perpetual Futures in Shaping Bitcoin and Ether 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, for bitcoin, ether, and the broader crypto market, perpetual futures, or 'perps,' have taken over, accounting for roughly 93% of all crypto futures volume. These leverage-friendly contracts never expire and can be held indefinitely by paying 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 U.S. spot exchanges reacting to these moves rather than leading them. A study found that Binance's perpetual market is the primary source of price formation across the fragmented crypto landscape, although the evidence is not conclusive, and some studies suggest spot markets still lead at certain frequencies or during stress. The direction of the literature, however, points towards the derivatives market as the place where prices are made. Historically, perpetual futures have led price rallies during bear markets, with the funding rate serving as a tether that keeps the contract anchored and a live readout of sentiment. The funding rate is paid by the crowded side of the trade every few hours, nudging the contract back toward the underlying price. This mechanism was observed in the pre-IPO trading of SpaceX, where perpetual futures contracts accurately predicted the company's stock price, outperforming Wall Street's valuation. The use of perpetual futures in pricing SpaceX's IPO demonstrates the influence of these contracts in discovering prices, even in the absence of a spot market. The contracts were able to price demand accurately but were blind to supply, highlighting the limitations of perpetual futures in certain market conditions. The case of SpaceX shows that the derivatives market is increasingly where price discovery occurs, with spot markets following. This phenomenon is not unique to SpaceX but is a characteristic of the crypto market, where perpetual futures drive price discovery, and spot markets react to these movements.