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. However, perpetual futures, which are leverage-friendly contracts that never expire, now account for approximately 93% of all crypto futures volume. These contracts, also known as 'perps', have been found to be the primary source of price formation in the fragmented crypto landscape. 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 reacting to, rather than leading, these moves. The funding rate, which is the cost of holding a perpetual contract, is a key component of this process, as it keeps the contract price anchored to the underlying asset and provides a live readout of market sentiment. The influence of perps can be seen in the pre-IPO trading of SpaceX, where traders on Binance, Coinbase, and other platforms were able to accurately price the company's valuation before its official listing. The perpetual market was able to read first-day demand more accurately than the banks that spent months building the offering price, highlighting the power of derivatives in price discovery. However, the perps' inability to account for supply was evident in the subsequent decline of SpaceX's stock price, which fell more than 40% from its peak due to the release of locked-up insider shares. This example illustrates the importance of understanding the role of perps in crypto markets and their limitations in pricing certain factors, such as supply.