How Perpetual Futures Dominate Bitcoin and Ether Markets, and the Lessons from SpaceX

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, for years, perpetual futures, also known as perpetual swaps or 'perps,' have played a more significant role in determining prices 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. Unlike traditional futures contracts, which have a settlement date and are forced to meet the spot price of the underlying asset, perpetual futures can be held indefinitely, with traders paying a funding rate that varies daily. Research has shown that derivatives markets, particularly perpetual swaps on unregulated venues, are the strongest instruments for bitcoin price discovery, with regulated futures and U.S. 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. Historically, perpetual futures have led price rallies during bear markets, with demand growth in perps leading spot demand. The funding rate, which is paid by the crowded side of the trade every few hours, acts as a tether that keeps the contract anchored to the underlying price and provides a live readout of sentiment. Some traders watch the funding rate closely, as it can provide insight into market sentiment. However, others view it as a cost that eats into their profit and loss while they wait for their directional position to become profitable. The use of perpetual futures contracts is not limited to crypto markets, as seen in the case of SpaceX, which used pre-IPO perpetual futures to price its initial public offering. Traders on various exchanges, including Binance and Hyperliquid, were buying and selling exposure to the company through these contracts before its IPO, and the perpetual market was able to accurately predict the first-day demand, with the stock opening at a price close to the predicted value. This example highlights the influence of derivatives markets in price discovery, even in traditional markets. The derivatives market is excellent at pricing demand but blind to supply, which can lead to significant price movements when supply becomes a factor, as seen in the case of SpaceX, where the stock price fell after locked-up insider shares became eligible to sell.