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 on exchanges. However, perpetual futures, also known as perps, have become the primary drivers of price discovery in the crypto market, accounting for around 93% of all crypto futures volume. These contracts are leverage-friendly, never expire, and can be held indefinitely by paying a funding rate that varies daily. Research has shown that perps are the strongest instruments for bitcoin price discovery, with regulated futures and spot exchanges reacting to their moves rather than leading them. A study found that perpetual swaps on unregulated venues were the primary source of price formation, while other work identified Binance's perpetual market as the main driver of price formation in the crypto landscape. The evidence is not conclusive, but the direction of research suggests that derivatives markets are where prices are made. Historically, perps have led price rallies during bear markets, with spot demand contracting while perps demand expanded. The funding rate, which is paid by the crowded side of the trade every few hours, acts as a tether to the underlying price and a live readout of sentiment. Traders watch it closely, as it provides predictability and insight into market sentiment. The use case of SpaceX, which had a record $75 billion IPO, demonstrates the power of perps in predicting prices. Traders on Binance, Coinbase, and other platforms were buying and selling exposure to SpaceX through pre-IPO perpetual futures, which accurately predicted the company's IPO price. The perpetual market was pricing SpaceX above the IPO price, allowing traders to bet on the gap between the perp and the eventual opening price. The stock's subsequent fall was due to supply issues, which the perp market could not have priced. This example illustrates the dominance of perps in price discovery, not just in crypto but also in traditional assets.