The Dominance of Perpetual Futures in Crypto Markets and Beyond

The process of setting crypto prices is often misunderstood, with many assuming it involves spot trading, where buyers and sellers meet on an exchange. However, the reality is that perpetual futures, also known as perpetual swaps or 'perps,' have been driving the price discovery for bitcoin, ether, and the broader crypto market for years. These leverage-friendly contracts never expire and account for roughly 93% of all crypto futures volume, with daily perp volume often surpassing the spot market. A key difference between traditional futures contracts and perps is that the latter has no settlement date and can be held indefinitely, provided the funding rate is paid. The funding rate is a cost that varies daily and is paid by the crowded side of the trade every few hours. This mechanism keeps the contract price anchored to the underlying asset and serves as a live readout of market sentiment. Research has shown that derivatives markets, particularly perpetual swaps on unregulated venues, are the primary drivers of bitcoin price discovery. A study published in the Journal of Financial Markets found that perpetual swaps were the strongest instruments for bitcoin price discovery, with regulated futures and U.S. spot exchanges reacting to, rather than leading, these moves. Other studies have identified Binance's perpetual market as the primary source of price formation across the fragmented crypto landscape. While the evidence is not conclusive, and some studies suggest that spot markets still lead at certain frequencies or during times of stress, the overall direction of the research points to the derivatives market as the primary driver of price discovery. The use of perpetual futures to price the IPO of SpaceX, a private company, demonstrates the accuracy of these contracts in predicting market demand. Traders on Binance, Coinbase, and other platforms were able to buy and sell exposure to SpaceX through pre-IPO perpetual futures, which ultimately priced the company's valuation more accurately than traditional Wall Street methods. The striking aspect of this example is how closely the perpetual futures contracts predicted the actual price of SpaceX's stock on its first day of trading. The contracts were quoting a price equivalent to roughly $170 a share, well above the $135 IPO price set by underwriters. The stock ultimately opened at $161, up 19% from the IPO price, and the perpetual market was able to capture this demand more accurately than traditional banking methods. However, the perpetual market's inability to account for supply-side factors, such as the release of locked-up insider shares, ultimately led to a significant decline in SpaceX's stock price. This example highlights the importance of understanding the role of perpetual futures in price discovery and their limitations in accounting for certain market factors.