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. However, perpetual futures, also known as perpetual swaps or 'perps', have become the primary drivers of price discovery 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. Research has shown that derivatives markets, particularly 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 priced the company's valuation before its initial public offering. The funding rate, which is the cost of holding a perpetual contract, is a key component of this process, as it provides a live readout of market sentiment and helps to keep the contract price anchored to the underlying asset. While the funding rate is important for traders, it can also be a source of cost, eating into profits for those holding directional positions. The use of perpetual futures contracts to price private companies like SpaceX has shown that these instruments can be used to discover prices in other markets, highlighting their versatility and potential for wider adoption. The example of SpaceX also demonstrates the limitations of perpetual futures in pricing supply, which can have a significant impact on market prices. Overall, the dominance of perpetual futures in crypto markets and their potential applications in other areas highlight the importance of understanding these instruments and their role in price discovery.