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

The process of setting crypto prices is often misunderstood, with many believing it occurs through 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 never expire and can be held indefinitely, with traders paying a funding rate that varies daily. Research has shown that perpetual swaps on unregulated venues are the strongest instruments for bitcoin price discovery, with regulated futures and US spot exchanges reacting to these moves. A study by Carol Alexander and co-authors found that perpetual swaps on unregulated venues led bitcoin price discovery, while other work has identified Binance's perpetual market as the primary source of price formation. The evidence suggests that the derivatives market is where prices are made, with spot markets following. Historically, perps have led price rallies during bear markets, with spot demand contracting while perps demand expands. The funding rate, which is paid by the crowded side of the trade every few hours, serves as a tether that keeps the contract anchored and provides a live readout of sentiment. Traders watch the funding rate closely, as it can indicate the market's direction. The use of perpetual futures contracts was recently demonstrated in the SpaceX IPO, where traders on Binance, Coinbase, and other platforms bought and sold exposure to the company through pre-IPO perpetual futures. These contracts accurately predicted the company's IPO price, with the perpetual market pricing SpaceX above the $135 IPO price. The stock's performance since the IPO has been influenced by supply, with locked-up insider shares becoming eligible to sell, causing the price to drop. This example illustrates the dominance of perpetual futures in price discovery, with spot markets following. Perps are excellent at pricing demand but blind to supply, which is an important consideration in crypto trading.