How Perpetual Futures Dominate Bitcoin and Ether Markets

The process of setting cryptocurrency prices is often misunderstood, with many believing it involves 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 primary drivers of price discovery for bitcoin, ether, and other cryptocurrencies. These contracts, which can be held indefinitely, account for approximately 93% of all crypto futures volume, with daily volumes often surpassing those of the underlying spot market. A key factor in perps is the funding rate, which is paid by the crowded side of the trade every few hours, serving as a sentiment indicator and keeping the contract price anchored to the underlying asset. Research has shown that perps are the strongest instruments for bitcoin price discovery, with some studies identifying Binance's perpetual market as the primary source of price formation. The use of perps in predicting the value of SpaceX's IPO is a notable example, where traders on Binance, Coinbase, and Hyperliquid accurately predicted the company's valuation, outperforming traditional Wall Street predictions. This highlights the increasing importance of the derivatives market in determining cryptocurrency prices, with spot markets following suit. The funding rate plays a crucial role in this process, as it provides a live readout of market sentiment and helps to keep the contract price in line with the underlying asset. While the evidence is not conclusive, and some studies suggest that spot markets still lead at certain frequencies or during times of stress, the direction of the literature suggests that the derivatives market is becoming the primary driver of price discovery for cryptocurrencies.