The Dominance of Perpetual Futures in Crypto Markets and Beyond

The process of setting crypto prices is often misunderstood, with many believing it occurs through 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 primary drivers of price discovery in the crypto market, accounting for approximately 93% of all crypto futures volume. These contracts are leverage-friendly, never expire, and can be held indefinitely by paying a funding rate that varies daily. 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, rather than leading, these moves. The evidence suggests that the derivatives market, particularly perpetual futures, is where prices are made, with spot markets following. This phenomenon was recently observed in the case of SpaceX's initial public offering, where perpetual futures contracts accurately predicted the company's stock price, outperforming traditional market predictions. The funding rate, which is the cost of holding a perpetual contract, plays a crucial role in this process, as it reflects market sentiment and influences price movements. While the funding rate is essential for traders, it can also be a double-edged sword, as it can eat into profits for those holding directional positions. The SpaceX example highlights the power of perpetual futures in pricing demand, but also their limitations in accounting for supply. As the crypto market continues to evolve, it is essential to understand the role of perpetual futures in driving price discovery and their potential impact on traditional markets.