The Dominance of Perpetual Futures in Crypto Markets and Beyond

The process of setting crypto prices is often misunderstood, with many believing it to be driven by spot trading. However, perpetual futures, or 'perps,' have become the primary driver of price discovery in the crypto market, accounting for around 93% of all crypto futures volume. These contracts, which never expire, allow for leverage-friendly trading and are settled through 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 US spot exchanges reacting to, rather than leading, these moves. The evidence suggests that the derivatives market is where prices are made, with spot markets following. This phenomenon is not limited to crypto, as seen in the recent SpaceX IPO, where perpetual futures contracts accurately predicted the company's stock price, outperforming traditional banking estimates. The use of perpetual futures in pricing SpaceX's valuation highlights the influence of these contracts in discovering prices, even in non-crypto markets. The funding rate, which is used to settle perpetual contracts, is a key component in understanding market sentiment and is closely watched by traders. However, it is not without its limitations, as it can be influenced by leverage-seeking retail traders and may not always accurately reflect market conditions. The SpaceX example demonstrates the power of perpetual futures in pricing demand, but also highlights their limitations in accounting for supply. As the crypto market continues to evolve, the role of perpetual futures in driving price discovery is likely to remain a key factor, with spot markets playing a secondary role.