The Dominance of Perpetual Futures in Crypto Markets

The process of setting crypto prices is often misunderstood, with many believing it is driven by spot trading. However, perpetual futures, also known as 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 are traded on various exchanges, including Binance and Coinbase. Research has shown that perps are the primary source of price formation in the crypto market, with spot exchanges reacting to their moves rather than leading them. A study by Carol Alexander and co-authors found that perpetual swaps on unregulated venues were the strongest instruments for bitcoin price discovery. Another study identified Binance's perpetual market as the primary source of price formation across the fragmented crypto landscape. The evidence is not conclusive, but the direction of the literature suggests that the derivatives market is where prices are made. The funding rate, which is the cost of holding a perp, plays a crucial role in keeping the contract price anchored to the underlying asset. Traders watch the funding rate closely, as it provides a live readout of market sentiment. The use of perps in pricing private companies like SpaceX has also been explored. In May and June, traders on various exchanges were buying and selling exposure to SpaceX through pre-IPO perpetual futures, which were structured to track an implied valuation rather than a share price. The striking part is how accurate these contracts were in predicting the company's IPO price. On the night before SpaceX listed, perpetuals on Hyperliquid and Binance were quoting the equivalent of roughly $170 a share, well above the $135 the underwriters had set. The next day, the stock opened at $161, up 19%, and printed almost exactly where the perps had it. This example highlights the ability of perps to price demand accurately, but also their limitations in pricing supply. As the derivatives market continues to grow in influence, it is essential to understand the role of perps in shaping crypto prices and the potential risks and opportunities they present.