The Dominance of Perpetual Futures in Crypto Markets and Beyond

The process of setting crypto prices is often misunderstood, with many believing it involves spot trading. However, perpetual futures, also known as perpetual swaps or 'perps,' have become the dominant force in the crypto markets, 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. Research has shown that derivatives markets, particularly perpetual swaps on unregulated venues, are the strongest instruments for bitcoin price discovery, with regulated futures and US spot exchanges reacting to these moves. The evidence suggests that the derivatives market is where prices are made, with spot markets following. This phenomenon was recently demonstrated in the case of SpaceX, where perpetual futures contracts accurately predicted the company's IPO price, outperforming traditional Wall Street estimates. 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 spot market still has a role to play, particularly during times of stress, the direction of the literature over the past few years has been toward the derivatives market as the primary driver of price discovery. The example of SpaceX, where perpetual futures contracts were used to predict the company's IPO price, highlights the power of these contracts in pricing demand. However, as seen in the subsequent decline of SpaceX's stock price, perpetual futures are blind to supply, which can have a significant impact on prices. In conclusion, the dominance of perpetual futures in crypto markets and beyond is a trend that is likely to continue, with these contracts playing an increasingly important role in shaping market prices.