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 where buyers and sellers meet on an exchange. However, for years, perpetual futures have played a more significant role in determining prices for bitcoin, ether, and the broader crypto market. These leverage-friendly contracts, which never expire, account for roughly 93% of all crypto futures volume, with daily volumes often surpassing those of the spot market. Unlike traditional futures contracts that have a settlement date where their price must align with the spot price of the underlying asset, perpetual futures can be held indefinitely by paying a funding rate that varies daily. Research has shown that perpetual swaps on unregulated venues are strong instruments for bitcoin price discovery, with regulated futures and U.S. spot exchanges reacting to moves in these derivatives markets. The evidence, while not conclusive, suggests that the derivatives market is where prices are made, with spot markets following. This phenomenon is not limited to cryptocurrencies, as demonstrated by the pricing of SpaceX's initial public offering (IPO) through pre-IPO perpetual futures contracts. These contracts, which were available on several exchanges including Binance, Coinbase, and Hyperliquid, accurately predicted the first-day trading price of SpaceX's stock, outperforming the underwriters' set price. This example highlights the influence of perpetual futures in price discovery, even in traditional markets. The funding rate, which is the cost of holding a perpetual futures contract, acts as a tether keeping the contract's price anchored to the underlying asset and provides a live readout of market sentiment. Traders closely watch the funding rate, as it reflects the balance between long and short positions in the market. While perpetual futures are excellent at pricing demand, they are blind to supply, a limitation that became apparent in the aftermath of the SpaceX IPO when the stock price fell due to an increase in supply. This experience underscores the importance of understanding the role of perpetual futures in price discovery and their limitations in pricing supply. In conclusion, the dominance of perpetual futures in crypto markets and their influence extending into traditional markets, as seen in the SpaceX IPO, demonstrate their significant role in price discovery and the need for a deeper understanding of their mechanics and limitations.