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, where buyers and sellers meet on an exchange. However, for years, perpetual futures, also known as perpetual swaps or 'perps,' have played a significant role in determining prices for bitcoin, ether, and the broader crypto market. These contracts, which never expire, account for roughly 93% of all crypto futures volume, with daily perp volume often surpassing the spot market. Perpetual futures allow traders to hold positions indefinitely by paying a funding rate, which varies daily. Research has shown that derivatives markets, particularly perpetual swaps on unregulated venues, are the strongest instruments for bitcoin price discovery, with regulated futures and U.S. spot exchanges reacting to these moves. A study found that Binance's perpetual market is the primary source of price formation across the fragmented crypto landscape. While the evidence is not conclusive, and some studies suggest spot markets still lead at certain frequencies or during stress, the literature points to the derivatives market as the primary price discovery mechanism. The funding rate, which is the cost of holding a perpetual contract, is a crucial factor in this process, as it 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, which used these contracts to price its record $75 billion initial public offering. Traders on exchanges like Binance, Coinbase, and Hyperliquid bought and sold exposure to the company through pre-IPO perpetual futures, which accurately predicted the company's IPO price. The perpetual market priced SpaceX well above the $135 IPO price, allowing traders to bet on the gap between the perp and the eventual opening price. This example demonstrates the power of perpetual futures in price discovery, even in traditional markets. However, the perp market is blind to supply, which can lead to price discrepancies, as seen in the case of SpaceX, where the stock price fell more than 40% from its June peak due to supply issues. In conclusion, perpetual futures have become a dominant force in crypto markets, and their influence extends beyond crypto to traditional markets, making them an essential tool for traders and investors.