The Dominance of Perpetual Futures in Crypto Markets and Beyond

The process of setting crypto prices is often misunderstood, with many believing it is driven by spot trading. However, perpetual futures, also known as perpetual swaps or 'perps,' have become the dominant force in the crypto market, accounting for approximately 93% of all crypto futures volume. These contracts, which never expire, allow traders to speculate on the price of an asset with leverage, and their influence is evident in the way they drive price discovery. 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, rather than leading, these moves. The evidence suggests that the derivatives market is where prices are made, with spot markets following. This phenomenon is not limited to cryptocurrencies, as seen in the case of SpaceX's initial public offering, where perpetual futures contracts accurately priced the company's value before its listing. The funding rate, which is the cost of holding a perpetual contract, plays a crucial role in this process, as it reflects the sentiment of traders and helps to keep the contract price anchored to the underlying asset. While the funding rate is important, some traders view it as a cost that eats into their profits, rather than a valuable data point. The use of perpetual futures contracts in pricing SpaceX's IPO highlights the power of these instruments in price discovery, even in traditional markets. The fact that these contracts were able to accurately predict the company's stock price on its first day of trading demonstrates the influence of the derivatives market in setting prices. However, the subsequent decline in SpaceX's stock price due to supply issues highlights the limitations of perpetual futures in pricing assets, as they are blind to supply and only reflect demand. Overall, the dominance of perpetual futures in crypto markets and beyond is a significant trend that reflects the increasing importance of derivatives in price discovery.