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 driver of price discovery in the crypto market, accounting for approximately 93% of all crypto futures volume. These contracts, which never expire, allow for leverage and are settled through 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 these moves rather than leading them. A study published in the Journal of Financial Markets found that perpetual swaps on unregulated venues were the primary source of price formation for bitcoin. Other research has identified Binance's perpetual market as the main driver of price formation across the fragmented crypto landscape. While some studies suggest that spot markets still lead at certain frequencies or during times of stress, the general consensus is that derivatives markets are where prices are made. The funding rate, which is used to settle perpetual contracts, is both a tether that keeps the contract anchored to the underlying price and a live readout of market sentiment. Traders closely watch the funding rate, as it provides valuable insights into market sentiment. The use of perpetual futures is not limited to crypto markets, as demonstrated by the case of SpaceX's initial public offering (IPO). Prior to the IPO, traders were buying and selling exposure to SpaceX through pre-IPO perpetual futures on various exchanges, including Binance, Coinbase, and Hyperliquid. These contracts were structured to track an implied valuation rather than a share price. The striking aspect of this case is how accurately the perpetual futures market predicted the 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 IPO price set by underwriters. The next day, SpaceX's stock opened at $161, up 19% from the IPO price, and reached an intraday high above $176. The perpetual market had accurately predicted the first-day demand, outperforming the banks that had spent months building the offering price. However, the perpetual market's inability to account for supply was evident when SpaceX's stock price fell more than 40% from its June peak, dropping from the $135 IPO price to around $115. This decline was largely due to the release of locked-up insider shares, which the perpetual market had not priced in. The SpaceX case demonstrates the dominance of perpetual futures in price discovery, even in traditional markets. The predictive power of perpetual futures is a testament to their influence in driving market prices, and their ability to accurately predict demand. However, their limitations in accounting for supply should not be overlooked.