Cryptocurrency Markets Are Dominated by Perpetual Futures, Even Influencing Traditional Stocks

The process of setting cryptocurrency prices is often misunderstood, with many believing it is driven by spot trading. However, perpetual futures, also known as perpetual swaps or 'perps,' have become the primary drivers of price discovery in the crypto market, accounting for around 93% of all crypto futures volume. These contracts, which can be held indefinitely, allow traders to bet on the price of an asset without actually owning it. Research has shown that perpetual swaps on unregulated venues are the strongest instruments for bitcoin price discovery, with regulated futures and U.S. spot exchanges reacting to these moves rather than leading them. 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 the main driver of price formation across the crypto landscape. While the evidence is not conclusive, with some studies suggesting that spot markets still lead at certain frequencies or during times of stress, the overall trend suggests that the derivatives market is where prices are made. Historically, perpetual futures have led price rallies during bear markets, with demand for these contracts expanding while spot demand contracts. The funding rate, which is the cost of holding a perpetual contract, plays a crucial role in keeping the contract price anchored to the underlying asset price. Traders watch the funding rate closely, as it provides a live readout of market sentiment. The use of perpetual futures to price SpaceX's IPO before its listing on the Nasdaq is a notable example of the influence of these contracts. Traders on platforms such as Binance, Coinbase, and Hyperliquid were able to buy and sell exposure to SpaceX through pre-IPO perpetual futures, which accurately predicted the company's first-day trading price. The perpetual market priced SpaceX above its IPO price, allowing traders to bet on the gap between the two prices. While the stock has since fallen, the example highlights the significant role that perpetual futures play in price discovery, even in traditional markets. The derivatives market is increasingly where prices are discovered, with spot markets following. Perpetual futures are excellent at pricing demand but are blind to supply, which can have significant implications for price movements.