The Dominance of Perpetual Futures in Crypto Markets

The process of setting crypto prices is often misunderstood, with many believing it is driven by spot trading, where buyers and sellers meet on an exchange. However, the reality is that perpetual futures, which are leverage-friendly contracts that never expire, now account for roughly 93% of all crypto futures volume. These contracts, also known as 'perps', have become the primary source of price formation in the crypto market. 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 is not conclusive, but the direction of the literature suggests that the derivatives market is where prices are made. The funding rate, which is the cost of holding a perpetual contract, is a key factor in this process, as it provides a live readout of sentiment and can influence the price of the contract. The recent SpaceX IPO provides a notable example of the influence of perpetual futures, as traders on Binance, Coinbase, and other platforms were able to accurately predict the company's stock price before it listed, using pre-IPO perpetual futures contracts. This highlights the growing importance of the derivatives market in price discovery, and how it can be used to predict market movements. The use of perpetual futures contracts in this way demonstrates their ability to price demand, but also highlights their limitations, as they are blind to supply. This can have significant implications for market participants, particularly in times of high volatility or when there are significant changes in market conditions.