The Dominance of Perpetual Futures in Crypto Markets and Beyond

The process of setting crypto prices is often misunderstood, with many believing it to be driven by spot trading. However, the reality is that perpetual futures, also known as perps, have taken over as the primary mechanism for price discovery in the crypto market. These contracts, which never expire, account for approximately 93% of all crypto futures volume and have become the go-to instrument for traders looking to leverage their positions. A key difference between traditional futures contracts and perps is the absence of a settlement date in the latter. This means that perps can be held indefinitely, with traders paying a funding rate that varies daily to maintain their positions. The funding rate serves as a tether that keeps the contract price anchored to the underlying asset and provides a live readout of market sentiment. Research has consistently shown that the derivatives market, particularly perpetual swaps on unregulated venues, plays a significant role in price discovery for bitcoin. Studies have found that these contracts are often the first to reflect new information in the market, with regulated futures and spot exchanges reacting to these moves rather than leading them. The influence of perps extends beyond the crypto market, as demonstrated by the case of SpaceX's initial public offering (IPO). Traders on various exchanges, including Binance and Coinbase, were able to buy and sell exposure to SpaceX through pre-IPO perpetual futures contracts, which accurately predicted the company's first-day trading price. This example highlights the ability of perps to price demand and their limitations in accounting for supply. The funding rate, which is a critical component of perps, has become a closely watched metric by traders. It provides a live readout of market sentiment and serves as a mechanism to keep the contract price in line with the underlying asset. However, some traders view the funding rate as a cost that eats into their profit and loss (PnL) rather than a valuable data point. The SpaceX example also demonstrates the limitations of perps in pricing supply. The company's IPO price was accurately predicted by the perpetual market, but the subsequent decline in the stock price was driven by supply-side factors that the perps could not account for. This highlights the importance of considering both demand and supply when evaluating market prices. In conclusion, perpetual futures have become a dominant force in the crypto market, and their influence extends to traditional markets. While they are excellent at pricing demand, they are blind to supply, which can lead to significant price movements. As the market continues to evolve, it is essential to understand the role of perps in price discovery and their limitations in accounting for supply.