The Dominance of Perpetual Futures in Crypto Markets and Beyond

The process of setting crypto prices is often misunderstood, with many believing it involves spot trading. However, perpetual futures, also known as perpetual swaps or 'perps,' have become the dominant force in the crypto market, accounting for approximately 93% of all crypto futures volume. These contracts are leverage-friendly, have no expiration date, and can be held indefinitely, making them highly influential in determining prices. Research has shown that derivatives markets, particularly perpetual swaps on unregulated venues, are the primary source of price discovery for bitcoin. The evidence suggests that the derivatives market leads the spot market, with some studies identifying Binance's perpetual market as the primary source of price formation. The funding rate, which is the cost of holding a perpetual contract, plays a crucial role in keeping the contract price anchored to the underlying spot price. The funding rate is also a live readout of market sentiment, making it a closely watched metric by traders. A notable example of the power of perpetual futures is the case of SpaceX's IPO, where traders on crypto exchanges were able to accurately price the company's valuation before its public listing, outperforming traditional Wall Street banks. This demonstrates the growing influence of derivatives markets in price discovery, not just in crypto but also in traditional markets. The derivatives market's ability to price demand accurately is a key factor in its dominance, although it can be blind to supply-side factors, as seen in the case of SpaceX's post-IPO price drop due to insider share sales.