The Dominance of Perpetual Futures in Crypto Markets and Beyond

The process of setting crypto prices is often misunderstood, with many believing it is driven by spot trading, where buyers and sellers meet on an exchange. However, perpetual futures, also known as perpetual swaps or 'perps,' have become the dominant force in the crypto market, accounting for roughly 93% of all crypto futures volume. These contracts are leverage-friendly, never expire, and can be held indefinitely by paying a funding rate that varies daily. A significant body of 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, where perpetual futures contracts accurately predicted the company's initial public offering price, outperforming traditional Wall Street valuations. The funding rate, which is the cost of holding a perpetual contract, plays a crucial role in this process, as it provides a live readout of market sentiment and keeps the contract price anchored to the underlying asset. Traders closely watch the funding rate, as it can indicate the direction of the market and provide opportunities for profit. The use of perpetual futures in pricing private companies like SpaceX has shown that these contracts can accurately predict market demand, even in the absence of a spot market. However, they are blind to supply, which can lead to price discrepancies. The dominance of perpetual futures in crypto markets and their potential applications in other areas highlights the importance of understanding these complex financial instruments and their role in shaping market prices.