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 years, perpetual futures, or 'perps', have been the main drivers of price discovery for Bitcoin, Ether, and the broader crypto market. These leverage-friendly contracts never expire and account for roughly 93% of all crypto futures volume, with daily volumes often surpassing those of the spot market. A key difference between traditional futures contracts and perps is the absence of a settlement date in the latter, allowing them to 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 moves initiated in the derivatives market. The evidence, while not conclusive, suggests that the derivatives market is where prices are made, with spot markets following. The funding rate, which is paid by the crowded side of the trade every few hours, acts as a tether keeping the contract price anchored to the underlying asset and provides a live readout of market sentiment. Traders watch the funding rate closely, as it can provide insights into market direction. The use of perpetual futures contracts is not limited to crypto markets, as demonstrated by the SpaceX IPO. Traders on various exchanges, including Binance and Coinbase, were buying and selling exposure to SpaceX through pre-IPO perpetual futures contracts before the company's record $75 billion initial public offering. These contracts were structured to track an implied valuation rather than a share price. The perpetual futures market accurately predicted the first-day demand for SpaceX shares, with prices on Hyperliquid and Binance quoting the equivalent of roughly $170 a share, well above the $135 IPO price set by underwriters. The stock opened at $161, up 19%, and the perpetual market was able to price the demand for SpaceX shares more accurately than traditional banks. However, the perpetual market's inability to account for supply meant that it was blind to the impending release of 900 million locked-up insider shares, which led to a significant drop in the stock price. The SpaceX example highlights the dominance of perpetual futures in price discovery, a trend that is also evident in ordinary crypto trading.