The Dominance of Perpetual Futures in Crypto Markets and Beyond

Most people believe that crypto prices are determined by spot trading, where buyers and sellers meet on an exchange. However, this has not been the case for years, particularly for bitcoin and ether. Perpetual futures, also known as perpetual swaps or 'perps,' are contracts that never expire and have become the dominant force in crypto markets, accounting for roughly 93% of all crypto futures volume. These contracts are leverage-friendly and can be held indefinitely, with traders paying a funding rate that varies daily. Research has shown that perpetual swaps 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. The evidence suggests that the derivatives market is where prices are made, with spot markets following. This phenomenon is not limited to crypto markets, as seen in the pre-IPO valuation of SpaceX, where perpetual futures contracts accurately predicted the company's stock price on its first day of trading. The funding rate, which is the cost of holding a perpetual contract, is a key factor in determining prices and is closely watched by traders. However, it is not a perfect indicator, as it can be influenced by sentiment and market conditions. The use of perpetual futures contracts in pricing SpaceX's pre-IPO valuation highlights the importance of these contracts in determining prices, even in traditional markets. The fact that these contracts were able to accurately predict the stock price on its first day of trading demonstrates the power of perpetual futures in price discovery. However, the subsequent decline in the stock price due to supply issues highlights the limitations of perpetual futures in pricing, which are excellent at pricing demand but blind to supply.