How Perpetual Futures Shape Bitcoin and Ether Prices

The mechanism of price setting in the cryptocurrency market has evolved over the years. While many believe that spot trading is the primary driver of price discovery, the reality is that perpetual futures, also known as perpetual swaps or 'perps,' have become the dominant force in shaping bitcoin and ether prices. These leverage-friendly contracts, which never expire, account for approximately 93% of all crypto futures volume, with daily perp volume often surpassing the spot market. A key difference between traditional futures contracts and perps is the absence of a settlement date in the latter, allowing them to be held indefinitely. However, this comes at a cost, known as the 'funding rate,' which varies daily. Research has consistently shown that derivatives markets, particularly perpetual swaps on unregulated venues, play a significant role in price discovery for bitcoin. One study found that perpetual swaps were the strongest instruments for bitcoin price discovery, with regulated futures and U.S. spot exchanges reacting to, rather than leading, these moves. Another study identified Binance's perpetual market as the primary source of price formation across the fragmented crypto landscape. While the evidence is not conclusive, and some studies suggest that spot markets still lead at certain frequencies or during times of stress, the overall trend in the literature points to the derivatives market as the primary driver of price discovery. The funding rate, which is both a tether that keeps the contract anchored and a live readout of sentiment, is closely watched by traders. The use of perpetual futures 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, including Binance and Coinbase, were buying and selling exposure to the company through pre-IPO perpetual futures. The striking aspect of this was how accurately the perpetual market priced the company's valuation, with the contracts quoting a price equivalent to roughly $170 a share, well above the $135 IPO price set by underwriters. On the day of the listing, the stock opened at $161, up 19%, and almost exactly where the perps had priced it. This example highlights the ability of the derivatives market to accurately price demand, but also its limitations in accounting for supply. As the market continues to evolve, it is essential to recognize the significant influence of perpetual futures on cryptocurrency prices and the importance of understanding the underlying mechanics of these contracts.