Perpetual Futures Dominate Bitcoin and Ether Markets, Proving Their Influence

The process of setting crypto prices is often misunderstood, with many believing it occurs through spot trading, where buyers and sellers meet on an exchange. However, for years, perpetual futures, also known as perpetual swaps or 'perps,' have played a significant role in determining prices for bitcoin, ether, and the broader crypto market. These contracts, which never expire, account for approximately 93% of all crypto futures volume, with daily perp volume often surpassing the spot market. A traditional futures contract has a settlement date when its price is forced to meet the spot price of the underlying asset. In contrast, perpetual futures have no such date and can be held indefinitely by paying a funding rate that varies daily. Research has shown that derivatives, particularly perpetual swaps on unregulated venues, are the primary drivers of bitcoin price discovery, with regulated futures and US spot exchanges reacting to these moves. A study published in the Journal of Financial Markets found that perpetual swaps were the strongest instruments for bitcoin price discovery, while other work identified Binance's perpetual market as the primary source of price formation in the crypto landscape. Although the evidence is not conclusive, with some studies suggesting spot markets still lead at certain frequencies or during stress, the direction of the literature over the past few years has been toward the derivatives market as the primary price discovery venue. The funding rate, which is paid by the crowded side of the trade every few hours, serves as a tether that keeps the contract anchored to the underlying price and provides a live readout of sentiment. Traders closely watch the funding rate, as it can indicate the market's direction. The use of perpetual futures contracts was recently demonstrated in the pricing of SpaceX's record $75 billion initial public offering. Traders on Binance, Coinbase, and other platforms bought and sold exposure to the company through pre-IPO perpetual futures, which accurately predicted the stock's first-day price. The perpetual market was pricing SpaceX above the $135 IPO price, allowing traders to bet on the gap between the perp and the eventual opening price. This example highlights the derivatives market's ability to discover prices, even for assets that have not yet been listed. However, the perp market's limitations were also evident, as it failed to account for the supply of locked-up insider shares that became eligible to sell after the IPO, leading to a significant drop in the stock price. In conclusion, the derivatives market, particularly perpetual futures, plays a crucial role in price discovery for bitcoin, ether, and other crypto assets, and its influence extends beyond the crypto space, as demonstrated by the accurate pricing of SpaceX's IPO.