The Dominance of Perpetual Futures in Cryptocurrency Markets

The mechanism 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, for years, perpetual futures, also known as perpetual swaps or 'perps', have been the main drivers of price discovery for bitcoin, ether, and the broader crypto market. These contracts, which never expire, account for roughly 93% of all crypto futures volume, with daily perp volume often surpassing the spot market. A key difference between traditional futures contracts and perps is the absence of a settlement date in perps, which allows them to be held indefinitely by paying a funding rate that varies daily. Research has shown that perps are the primary source of price formation in the crypto market, with studies indicating that derivatives markets lead spot markets in price discovery. For instance, a study in the Journal of Financial Markets found that perpetual swaps on unregulated venues were the strongest instruments for bitcoin price discovery. Other work has identified Binance's perpetual market as the primary source of price formation across the fragmented crypto landscape. The evidence is not conclusive, and some studies find spot still leads at certain frequencies or during stress. However, the direction of the literature over the past few years has been toward the derivatives market as the place where the price is made. The funding rate, which is paid by the crowded side of the trade every few hours, serves as a tether that keeps the contract anchored to the underlying price and provides a live readout of sentiment. Traders closely watch the funding rate, as it can provide valuable insights into market sentiment. The influence of perps is not limited to crypto markets, as seen in the case of SpaceX, which had a record $75 billion initial public offering. Traders on Binance, Coinbase, Hyperliquid, and others were buying and selling exposure to the company through pre-IPO perpetual futures before it began trading on the Nasdaq. The striking part is how accurately these contracts priced the company's valuation, with perpetuals on Hyperliquid and Binance quoting the equivalent of roughly $170 a share, well above the $135 set by underwriters. The stock opened at $161, up 19%, and the perpetual market had read first-day demand more accurately than the banks that spent months building the offering price. This example illustrates the dominance of perpetual futures in price discovery, even in traditional markets. However, it also highlights the limitations of perps in pricing supply, as seen in the subsequent decline of SpaceX's stock price due to the release of locked-up insider shares.