The Dominance of Perpetual Futures in Crypto Markets and Beyond

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 several years, perpetual futures, or 'perps,' have been the main drivers of price discovery in the crypto market, accounting for about 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, including a study in the Journal of Financial Markets, 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, is where prices are made, with spot markets following. This was illustrated in the pricing of SpaceX's record $75 billion initial public offering, where pre-IPO perpetual futures contracts accurately predicted the stock's first-day price, outperforming traditional underwriters. The funding rate, which is the cost of holding a perpetual contract, plays a crucial role in this process, acting as a tether that keeps the contract price anchored to the underlying asset and providing a live readout of market sentiment. However, while perpetual futures are excellent at pricing demand, they are blind to supply, which can lead to significant price movements when supply factors are introduced, as seen in the post-IPO price drop of SpaceX.