The Dominance of Perpetual Futures in Crypto Markets

The process of setting crypto prices is often misunderstood, with many believing it is determined by spot trading, where buyers and sellers meet on an exchange. However, in reality, perpetual futures, also known as perpetual swaps or 'perps', have become the primary driver of price discovery for bitcoin, ether, and other cryptocurrencies, accounting for approximately 93% of all crypto futures volume. These leverage-friendly contracts never expire and can be held indefinitely, with traders 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 US 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 is evident in the case of SpaceX's IPO, where perpetual futures accurately predicted the company's stock price, outperforming traditional Wall Street predictions. The funding rate, which is used to keep perpetual contracts anchored to the underlying price, is also a key indicator of market sentiment, with traders closely watching it to gauge the direction of the market. However, the funding rate is not without its limitations, as it can be influenced by factors such as supply and demand, which can affect the accuracy of price predictions. Ultimately, the dominance of perpetual futures in crypto markets highlights the importance of understanding the role of derivatives in shaping market trends and prices.