The Dominance of Perpetual Futures in Crypto Markets and Beyond

The process of setting crypto prices is often misunderstood, with many believing it is driven by spot trading. However, perpetual futures, which are leverage-friendly contracts with no expiration date, now account for approximately 93% of all crypto futures volume. These contracts, also known as perpetual swaps, have been shown to be the primary source of price formation in the crypto market, with research indicating that they lead spot markets in terms of price discovery. A study published in the Journal of Financial Markets found that perpetual swaps on unregulated venues were the strongest instruments for bitcoin price discovery, with regulated futures and U.S. 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, as demonstrated by the use of perpetual futures to value private companies like SpaceX. In the lead-up to SpaceX's initial public offering, traders used perpetual futures contracts to speculate on the company's valuation, with the contracts ultimately proving to be more accurate than the IPO price set by underwriters. The success of these contracts in predicting the company's valuation highlights the growing influence of perpetual futures in the financial markets. The funding rate, which is the cost of holding a perpetual contract, plays a crucial role in maintaining the contract's price and is closely watched by traders as a sentiment indicator. While perpetual futures are excellent at pricing demand, they are blind to supply, which can lead to price discrepancies. The use of perpetual futures to value SpaceX and other companies demonstrates the versatility and power of these contracts in the financial markets.