The Dominance of Perpetual Futures in Crypto Markets and Beyond

The process of setting crypto prices is often misunderstood, with many believing it is determined by spot trading, where buyers and sellers meet on an exchange. However, the reality is that perpetual futures, also known as perpetual swaps or 'perps,' have become the primary drivers of price discovery in the crypto market, accounting for approximately 93% of all crypto futures volume. Perps are leverage-friendly contracts that never expire and can be held indefinitely, with the price being adjusted through a funding rate that varies daily. Studies have shown that perps on unregulated venues are the strongest instruments for bitcoin price discovery, with regulated futures and spot exchanges reacting to, rather than leading, these moves. The evidence is not conclusive, but the direction of research suggests that the derivatives market is where prices are made. A notable example of the power of perps is the pricing of SpaceX's initial public offering, where perpetual futures contracts accurately predicted the stock's first-day price, outperforming traditional Wall Street predictions. This example highlights the ability of perps to price demand, but also their blindness to supply, which can lead to significant price movements. The funding rate, which is used to adjust the price of perps, is a key indicator of market sentiment and is closely watched by traders. In the case of SpaceX, the perpetual market was able to accurately predict the stock's first-day price, but was unable to account for the subsequent supply of locked-up insider shares, leading to a significant price drop. This example demonstrates the importance of understanding the role of perps in price discovery and their limitations in accounting for supply and demand.