How Perpetual Futures Dominate Bitcoin and Ether Markets, as Evidenced by SpaceX's IPO

The process of determining crypto prices is often misunderstood, with many believing it to be driven by spot trading, where buyers and sellers meet on an exchange and the last trade sets the price. However, for years, perpetual futures, also known as perpetual swaps or 'perps,' have been the primary drivers of price discovery in the crypto market, accounting for approximately 93% of all crypto futures volume. These contracts, which never expire and can be held indefinitely, have been shown to lead price movements in the market, with spot exchanges reacting to their moves rather than leading them. Research has consistently pointed to derivatives markets, particularly perpetual swaps, as the primary source of price formation for bitcoin and other cryptocurrencies. A study published in the Journal of Financial Markets found that perpetual swaps on unregulated venues were the strongest instruments for bitcoin price discovery, with regulated futures and US spot exchanges reacting to their moves. Another study identified Binance's perpetual market as the primary source of price formation across the fragmented crypto landscape. Historically, perpetual futures have led price rallies during bear markets, with demand for these contracts expanding while spot demand contracts. The funding rate, which is the cost of holding a perpetual contract, plays a crucial role in maintaining the contract's price in relation to the underlying asset. When the contract trades above spot, traders who are long pay those who are short, nudging the contract's price back toward the underlying price. The funding rate is also a live readout of market sentiment, with some traders watching it closely. The use of perpetual futures contracts to price private companies ahead of their IPO has also been demonstrated, as seen in the case of SpaceX. Traders on Binance, Coinbase, and other exchanges were able to buy and sell exposure to SpaceX through pre-IPO perpetual futures, with the contracts pricing the company's valuation accurately ahead of its listing. The perpetual market was able to read first-day demand more accurately than the banks that spent months building the offering price, with the stock opening at a price that was close to the price quoted by the perpetual contracts. However, the perpetual market is blind to supply, which can lead to price discrepancies when the underlying asset is affected by factors such as locked-up insider shares becoming eligible to sell. The example of SpaceX's IPO demonstrates the increasing influence of derivatives markets in price discovery, with perpetual futures contracts playing a key role in determining the price of cryptocurrencies and other assets.