The Dominance of Perpetual Futures in Crypto Markets and Beyond

The process of setting crypto prices is often misunderstood, with many believing it occurs through spot trading, where buyers and sellers meet on an exchange. However, for years, perpetual futures have played a more significant role in determining prices for bitcoin, ether, and the broader crypto market. These leverage-friendly contracts, also known as perpetual swaps, never expire and currently account for around 93% of all crypto futures volume, with daily volumes often surpassing those of the spot market. Unlike traditional futures contracts, which have a settlement date and are forced to meet the spot price of the underlying asset, perpetual futures can be held indefinitely, with traders paying a funding rate that 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 US spot exchanges reacting to these moves rather than leading them. A study by Carol Alexander and co-authors found that perpetual swaps were the primary source of price formation for bitcoin, while other work has identified Binance's perpetual market as the main driver of price formation across the fragmented crypto landscape. Although the evidence is not conclusive, with some studies suggesting spot markets still lead at certain frequencies or during times of stress, the overall direction of research points to derivatives markets as the primary location for price discovery. The funding rate, which is paid by the crowded side of the trade every few hours, serves as both an anchor for the contract price and a live indicator of market sentiment. Traders closely watch the funding rate, as it provides insight into the market's direction. The use of perpetual futures contracts is not limited to crypto markets, as demonstrated by the recent SpaceX IPO. For about three weeks, traders were able to buy and sell exposure to the company through pre-IPO perpetual futures contracts on various exchanges, including Binance, Coinbase, and Hyperliquid. These contracts were structured to track an implied valuation rather than a share price and accurately predicted the company's IPO price. On the night before SpaceX listed, perpetuals on Hyperliquid and Binance were quoting the equivalent of roughly $170 a share, well above the $135 set by underwriters. The stock opened at $161, up 19%, and the perpetual market had read first-day demand more accurately than the banks that spent months building the offering price. However, the perpetual market's inability to account for supply ultimately led to a significant drop in the stock price, with SPCX falling over 40% from its June peak. This example highlights the dominance of perpetual futures in price discovery, not only in crypto markets but also in traditional markets, and demonstrates their limitations in accounting for supply-side factors.