How Perpetual Futures Dominate Bitcoin and Ether Markets, and What SpaceX Taught Us

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 bitcoin, ether, and the broader crypto market, perpetual futures, also known as perpetual swaps or 'perps', have become the primary drivers of price discovery, accounting for roughly 93% of all crypto futures volume. Perps are leverage-friendly contracts that never expire and can be held indefinitely by paying a funding rate. Research has shown that perps on unregulated venues are the strongest instruments for bitcoin price discovery, with regulated futures and US spot exchanges reacting to, rather than leading, 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, the direction of the literature points towards the derivatives market as the place where the price is made. Historically, perps have led mostly during bear market price rallies. The funding rate, which is paid by the crowded side of the trade every few hours, is both the tether that keeps the contract anchored and a live readout of sentiment. Traders watch it closely, as it provides a unique insight into market sentiment. The funding rate is also what keeps the contract price tied to the underlying asset. A notable example of the power of perps is the case of SpaceX's initial public offering (IPO), which was priced at $135 a share. Before the IPO, traders on various exchanges, including Binance and Coinbase, were buying and selling exposure to SpaceX through pre-IPO perpetual futures. These contracts were structured to track an implied valuation rather than a share price. The striking aspect of this case is how accurately the perpetuals priced the stock before its listing. On the night before SpaceX listed, perpetuals on Hyperliquid and Binance were quoting the equivalent of roughly $170 a share, well above the $135 IPO price. The next day, the stock opened at $161, up 19%, and printed almost exactly where the perps had it. This example demonstrates the predictive power of perps and how they can read market demand more accurately than traditional markets. However, perps are blind to supply, which is what led to the subsequent drop in SpaceX's stock price after the IPO. As the market that had predicted the IPO price caught up with reality, the stock price fell more than 40% from its peak. This case study highlights the importance of understanding the role of perps in crypto markets and their limitations. In conclusion, perpetual futures are a crucial component of the crypto market, driving price discovery and providing unique insights into market sentiment. While they have their limitations, they have proven to be a powerful tool for traders and investors alike.