The Dominance of Perpetual Futures in Bitcoin and Ether Markets

The process of setting crypto prices is often misunderstood, with many believing it involves spot trading on exchanges. 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. 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 is evident in the case of SpaceX, where perpetual futures contracts accurately predicted the company's IPO price, outperforming traditional banking methods. The funding rate, which is the cost of holding a perpetual contract, plays a crucial role in price discovery, as it reflects market sentiment and influences the contract's price. Traders closely watch the funding rate, as it provides a live readout of market sentiment. However, the funding rate can also eat into a trader's profit and loss, making it a crucial aspect of trading perpetual futures. The use of perpetual futures contracts in pricing private companies like SpaceX demonstrates their versatility and accuracy in predicting market demand. While they are excellent at pricing demand, they are blind to supply, which can lead to discrepancies in pricing. The influence of perpetual futures contracts on the crypto market is undeniable, and their role in price discovery will likely continue to grow.