How Perpetual Futures Dominate Bitcoin and Ether Markets, and Their Surprising Accuracy in Pricing SpaceX's IPO

The process of setting crypto prices is often misunderstood, with many believing it occurs through spot trading. 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, have no expiration date, and can be held indefinitely by paying 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 U.S. spot exchanges reacting to, rather than leading, these moves. The primary source of price formation in the crypto landscape has been identified as Binance's perpetual market. While the evidence is not conclusive, and some studies suggest spot trading still leads at certain frequencies or during times of stress, the direction of the literature points to the derivatives market as the primary location for price discovery. A study by Carol Alexander and co-authors found that perpetual swaps on unregulated venues were the strongest instruments for bitcoin price discovery. The funding rate, which is paid by the crowded side of the trade every few hours, acts as a tether that keeps the contract anchored to the underlying price and provides a live readout of market sentiment. Traders watch the funding rate closely, as it can provide valuable insights into market dynamics. The use of perpetual futures contracts in pricing SpaceX's initial public offering (IPO) provides a unique example of their influence. Despite the company having never sold a public share, traders on various exchanges were able to buy and sell exposure to the company through pre-IPO perpetual futures. These contracts, which were structured to track an implied valuation rather than a share price, accurately predicted the company's IPO price. On the night before SpaceX listed, perpetuals on Hyperliquid and Binance were quoting the equivalent of roughly $170 a share, well above the $135 set by underwriters. The stock opened at $161, up 19%, and the perpetual market had read first-day demand more accurately than the banks that spent months building the offering price. However, the perpetual market's inability to account for supply meant that it was blind to the impending release of locked-up insider shares, which ultimately led to a decline in the stock price. This example highlights the importance of perpetual futures in price discovery, as well as their limitations. The derivatives market is increasingly where price gets discovered, and spot follows. Perps are excellent at pricing demand but blind to supply, a fact worth remembering in times of bitcoin rallies or flushes that start in the funding rate before reaching spot.