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. However, perpetual futures, or 'perps,' have become the primary driver of price discovery in the crypto market, accounting for roughly 93% of all crypto futures volume. These contracts, which never expire, allow traders to buy and sell with leverage, and their prices are influenced by funding rates. Research has shown that perpetual swaps on unregulated venues are often the strongest indicators of bitcoin price discovery, with regulated futures and spot exchanges reacting to these moves. 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 a key driver of price formation across the crypto landscape. The funding rate, which is paid by the crowded side of the trade every few hours, serves as a tether to the underlying price and a live readout of sentiment. Traders closely watch the funding rate, as it can provide insight into market sentiment. The use of perpetual futures to price pre-IPO companies, such as SpaceX, has also shown the power of these contracts in predicting market demand. In the case of SpaceX, perpetual futures on Binance and Hyperliquid accurately predicted the company's first-day trading price, outperforming traditional underwriters. This example highlights the importance of derivatives markets in price discovery, even for traditional assets. The derivatives market is increasingly where price gets discovered, with spot markets following. Perps are excellent at pricing demand but are blind to supply, which can lead to significant price movements when supply is introduced into the market.