The Dominance of Perpetual Futures in Crypto Markets and Beyond

The process of setting crypto prices is often misunderstood, with many assuming it's based on spot trading where buyers and sellers meet on an exchange. However, the reality is that perpetual futures, also known as perpetual swaps or 'perps,' have become the dominant force in the crypto market, accounting for around 93% of all crypto futures volume. These contracts are leverage-friendly, never expire, and can 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 US spot exchanges reacting to these moves rather than leading them. A study in the Journal of Financial Markets found that perpetual swaps were the primary source of price formation across the fragmented crypto landscape. The evidence suggests that the derivatives market is where prices are made, with spot markets following. Historically, perpetual futures have led price rallies during bear markets, with demand growth in perps leading spot demand. The funding rate, which is paid by the crowded side of the trade every few hours, acts as a tether keeping the contract anchored to the underlying price and provides a live readout of sentiment. Traders watch the funding rate closely, as it can impact their profits. The use of perpetual futures in pricing the SpaceX IPO before it listed on the Nasdaq is a notable example of the influence of these contracts. Traders on Binance, Coinbase, and other platforms were buying and selling exposure to SpaceX through pre-IPO perpetual futures, which accurately predicted the company's first-day trading price. The perpetual market was pricing SpaceX above the IPO price, allowing traders to bet on the gap between the perp and the eventual opening price. This gap was where the money was, as the contracts were built to automatically switch over to SpaceX's real share price once the stock began trading. The success of perpetual futures in pricing the SpaceX IPO highlights their growing influence in the financial markets. The derivatives market is increasingly where price discovery happens, with spot markets following. Perpetual futures are excellent at pricing demand but blind to supply, which is worth remembering in times of market volatility.