The Dominance of Perpetual Futures in Crypto Markets: A Lesson from SpaceX

The way cryptocurrency prices are set has evolved over the years, with perpetual futures, also known as perps, playing a significant role in price discovery. These contracts, which can be held indefinitely, account for approximately 93% of all crypto futures volume, often surpassing the spot market in terms of daily trading volume. Unlike traditional futures contracts, which have a settlement date, perps do not expire and can be held indefinitely by paying a funding rate that varies daily. Research has shown that derivatives markets, particularly perpetual swaps on unregulated venues, are leading the price discovery for bitcoin, with spot exchanges and regulated futures markets reacting to these moves. A study published in the Journal of Financial Markets found that perpetual swaps were the strongest instruments for bitcoin price discovery, while other work has identified Binance's perpetual market as the primary source of price formation in the crypto landscape. The evidence, however, is not conclusive, and some studies suggest that spot markets still lead at certain frequencies or during times of stress. The funding rate, which is the cost of holding a perp, serves as a tether that keeps the contract price anchored to the underlying asset and provides a live readout of market sentiment. Traders closely watch the funding rate, as it can indicate the direction of the market. The use of perpetual futures contracts is not limited to crypto markets, as seen in the case of SpaceX's initial public offering (IPO). Traders on various exchanges, including Binance and Coinbase, were buying and selling exposure to SpaceX through pre-IPO perpetual futures contracts, which were structured to track an implied valuation rather than a share price. These contracts accurately predicted the first-day trading price of SpaceX, with the perpetual market pricing the stock well above the IPO price. The gap between the perp price and the eventual opening price provided a trading opportunity, but the market's prediction was short-lived, as the stock price fell significantly after the IPO. The reason for the decline was the limited supply of shares sold at the IPO, which was not factored into the perp price. The SpaceX example highlights the dominance of perpetual futures in price discovery, not only in crypto markets but also in other areas. Perps are excellent at pricing demand but are blind to supply, which is an important consideration for traders and investors.