The Dominance of Perpetual Futures in Crypto and Stock Markets

The process of setting crypto prices is often misunderstood, with many believing it is driven by spot trading. However, perpetual futures, also known as perpetual swaps or 'perps,' have become the primary drivers of price discovery in the crypto market, accounting for approximately 93% of all crypto futures volume. These contracts, which never expire, allow traders to buy and sell with leverage, and their prices are influenced by 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 case of SpaceX's initial public offering, where perpetual futures contracts accurately predicted the company's stock price before it listed. The funding rate, which is both a tether that keeps the contract anchored and a live readout of sentiment, plays a crucial role in price discovery. Traders watch it closely, as it provides a live readout of market sentiment. However, the funding rate is not without its limitations, as it can eat into a trader's profit and loss while they wait for their position to become profitable. The use of perpetual futures in pricing demand and predicting market trends has significant implications for traders and investors, highlighting the importance of understanding the role of derivatives in price discovery.