The Dominance of Perpetual Futures in Crypto Markets and Beyond

The mechanism behind crypto price setting is often misunderstood, with many believing it is driven by spot trading. However, perpetual futures, or 'perps,' have become the primary drivers of price discovery in the crypto market, including for bitcoin and ether. These contracts, which are leverage-friendly and have no expiration date, account for approximately 93% of all crypto futures volume. The funding rate, a cost associated with holding these contracts, serves as a tether to the underlying asset's price and provides a live readout of market sentiment. Research has shown that perpetual swaps on unregulated venues are the strongest instruments for bitcoin price discovery, with regulated futures and U.S. spot exchanges often reacting to moves initiated in the derivatives market. A notable example of the power of perpetual futures in price discovery is the pre-IPO pricing of SpaceX, where traders on various platforms were able to accurately predict the company's initial public offering price using perpetual futures contracts. This instance highlights the ability of the derivatives market to lead price discovery, even in the absence of a traditional spot market. The funding rate plays a crucial role in this process, as it reflects the sentiment of traders and influences the price of perpetual contracts. While spot demand can contract, the demand for perpetual futures can expand, leading prices in the derivatives market to move ahead of those in the spot market. The case of SpaceX demonstrates that the derivatives market can accurately price demand but may be blind to supply-side factors, such as the availability of locked-up insider shares. As the crypto market continues to evolve, the importance of perpetual futures in driving price discovery is likely to endure.