The Overwhelming Influence of Perpetual Futures on Crypto Markets

The process of setting crypto prices is often misunderstood, with many believing it's driven by spot trading, where buyers and sellers meet on an exchange. However, perpetual futures, or 'perps,' have become the dominant force in the crypto market, accounting for roughly 93% of all crypto futures volume. These contracts never expire 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 these moves. 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 a key driver of price formation across the crypto landscape. The evidence suggests that the derivatives market is where prices are made, with spot markets following. This was exemplified by the SpaceX IPO, where perpetual futures contracts accurately predicted the company's valuation, outperforming traditional Wall Street predictions. The funding rate, which is used to keep the contract price anchored to the underlying asset, is also a key indicator of market sentiment. Traders watch the funding rate closely, as it provides a live readout of market sentiment. However, the funding rate can also eat into a trader's profit and loss, making it a crucial factor to consider when holding directional positions. The use of perpetual futures contracts to predict the valuation of SpaceX prior to its IPO demonstrates the power of these contracts in price discovery. The contracts were able to accurately predict the company's valuation, with the price of the contracts converging with the stock price on the day of the IPO. This example highlights the importance of perpetual futures in the crypto market and their ability to drive price discovery. The influence of perpetual futures extends beyond the crypto market, with their use in predicting the valuation of private companies like SpaceX. The contracts' ability to accurately predict the company's valuation demonstrates their potential as a tool for price discovery in other markets.