The Dominance of Perpetual Futures in Crypto Markets and Beyond

The process of setting crypto 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 bitcoin, ether, and the broader crypto markets. These contracts, which are leverage-friendly and never expire, account for roughly 93% of all crypto futures volume, with daily perp volume often surpassing the spot 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. A study in the Journal of Financial Markets found that perpetual swaps on unregulated venues were the primary source of price formation for bitcoin, while 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, 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 price discovery, as it reflects the sentiment of traders and keeps the contract price anchored to the underlying asset. Traders watch the funding rate closely, as it provides a live readout of market sentiment. The use of perpetual futures contracts to price private companies, such as SpaceX, has also been explored. In the lead-up to SpaceX's initial public offering, traders on various exchanges were buying and selling exposure to the company through pre-IPO perpetual futures contracts. These contracts were structured to track an implied valuation rather than a share price and were able to accurately predict the company's first-day trading price. The success of these contracts in pricing SpaceX's valuation highlights the potential of perpetual futures in price discovery, even in markets where traditional spot trading is not available. However, the limitations of perpetual futures in pricing supply were also evident, as the contracts were unable to account for the large number of locked-up insider shares that became eligible to sell after the IPO. Overall, the dominance of perpetual futures in crypto markets and their potential applications in other areas, such as private company valuation, highlight the importance of these contracts in modern financial markets.