The Dominance of Perpetual Futures in Crypto Markets

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 market, accounting for approximately 93% of all crypto futures volume. These contracts, which never expire, allow traders to buy and sell with leverage, and their prices are determined by the funding rate, which is paid by the more crowded side of the trade every few hours. Research has shown that perpetual swaps on unregulated venues are the strongest instruments for bitcoin price discovery, with regulated futures and spot exchanges reacting to, rather than leading, these moves. A study by Carol Alexander and co-authors found that perpetual swaps on unregulated venues were the primary source of price formation for bitcoin, while other work has identified Binance's perpetual market as the main driver of price formation across the crypto landscape. The evidence suggests that the derivatives market is where prices are made, with spot markets following. This was evident in the pricing of SpaceX's initial public offering, where perpetual futures contracts accurately predicted the company's valuation, outperforming traditional markets. The funding rate, which is both a tether that keeps the contract anchored and a live readout of sentiment, is closely watched by traders. However, it is not without its limitations, as it can be eaten into by traders holding directional positions for extended periods. The influence of perpetual futures extends beyond crypto, with their ability to price demand and predict market movements making them a powerful tool for traders. As the market continues to evolve, it is likely that perpetual futures will remain a dominant force in shaping prices and driving market trends.