The Dominance of Perpetual Futures in Cryptocurrency Markets

The mechanism of setting crypto prices is often misunderstood, with many believing it is determined by spot trading, where buyers and sellers meet on an exchange. However, for years, perpetual futures, also known as perpetual swaps or 'perps', have been driving the price discovery of bitcoin, ether, and other cryptocurrencies, accounting for roughly 93% of all crypto futures volume. These contracts are leverage-friendly, 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 US spot exchanges reacting to, rather than leading, these moves. The evidence suggests that the derivatives market is where the price is made, with spot markets following. This phenomenon was recently observed in the IPO of SpaceX, where perpetual futures contracts accurately predicted the company's stock price, outperforming traditional Wall Street predictions. The funding rate, which is the cost of holding a perpetual contract, is a key factor in determining the price of these contracts and is closely watched by traders. While perpetual futures are excellent at pricing demand, they are blind to supply, which can lead to significant price movements when supply and demand are out of balance.