The Dominance of Perpetual Futures in Crypto Markets and Beyond

The process of determining crypto prices is often misunderstood, with many believing it is driven by spot trading. However, perpetual futures, also known as perps, have become the dominant force in the crypto market, accounting for approximately 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. Research has shown that perps are the primary source of price formation in the crypto market, with spot exchanges reacting to their moves rather than leading them. A study found that perpetual swaps on unregulated venues were the strongest instruments for bitcoin price discovery, while other work identified Binance's perpetual market as the primary source of price formation. The funding rate, which is paid by the crowded side of the trade every few hours, serves as a tether that keeps the contract anchored to the underlying price and provides a live readout of market sentiment. The use of perps in valuing private companies like SpaceX has also been explored, with traders buying and selling exposure to the company through pre-IPO perpetual futures. The accuracy of these contracts in predicting the company's IPO price was striking, with perpetuals on Hyperliquid and Binance quoting the equivalent of roughly $170 a share, well above the $135 IPO price set by underwriters. The stock's first-day performance closely matched the predictions of the perp market, demonstrating the power of derivatives in price discovery. However, the subsequent decline of the stock price due to supply issues highlights the limitations of perps in pricing supply. The dominance of perps in crypto trading and their increasing influence on other markets underscores the importance of understanding these contracts and their role in shaping market prices.