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 crypto markets, accounting for approximately 93% of all crypto futures volume. These contracts are leverage-friendly, have no expiration date, and can be held indefinitely by paying a funding rate. Research has shown that perpetual swaps on unregulated venues are the strongest instruments for bitcoin price discovery, with regulated futures and spot exchanges reacting to these moves. A study found that Binance's perpetual market is the primary source of price formation in the fragmented crypto landscape. While the evidence is not conclusive, the direction of research suggests that derivatives markets are leading the way in price discovery. Historically, perps have led price rallies during bear markets. The funding rate, which is paid by the crowded side of the trade every few hours, keeps the contract price anchored to the underlying asset and serves as a live readout of market sentiment. The recent case of SpaceX's IPO, where perpetual futures contracts accurately predicted the stock's opening price, demonstrates the power of perps in price discovery. However, perps are blind to supply, which can lead to discrepancies between the contract price and the underlying asset's price. As seen in the case of SpaceX, the stock price fell significantly after the IPO due to supply issues, highlighting the limitations of perps in pricing supply. The dominance of perps in crypto markets and their influence on traditional markets is a trend that is likely to continue, with spot markets following the lead of derivatives markets.