The Dominance of Perpetual Futures in Crypto Markets and Beyond

The process of establishing a crypto price is often misunderstood, with many assuming it is determined by spot trading. However, the reality is that perpetual futures, also known as perpetual swaps or 'perps,' have become the dominant force in crypto markets, accounting for approximately 93% of all crypto futures volume. These contracts, which can be held indefinitely, allow traders to speculate on price movements without the constraints of traditional futures contracts, which have a settlement date. 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. 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 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, plays a crucial role in maintaining the contract's price and is closely watched by traders as a live readout of sentiment. The use of perpetual futures contracts to price SpaceX's IPO is a notable example of the influence of these contracts in traditional markets. Traders on Binance, Coinbase, and other platforms were able to buy and sell exposure to SpaceX through pre-IPO perpetual futures, which accurately priced the company's valuation prior to its listing. The perpetual market was able to read first-day demand more accurately than the banks that spent months building the offering price, demonstrating the power of perpetual futures in price discovery. However, the limitations of perpetual futures in pricing supply were also evident, as the contract was unable to account for the locked-up insider shares that became eligible to sell after the IPO. The dominance of perpetual futures in crypto markets and their increasing influence in traditional markets highlights the importance of understanding these contracts and their role in price discovery.