The Dominance of Perpetual Futures in Crypto Markets and Beyond

The process of setting crypto prices is often misunderstood, with many believing it involves spot trading. However, perpetual futures, also known as perpetual swaps or '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, with traders paying a funding rate that varies daily. Research has shown that derivatives markets, particularly perpetual swaps, are where new information enters the market first, leading to price discovery. A study found that perpetual swaps on unregulated venues were the strongest instruments for bitcoin price discovery, with regulated futures and U.S. spot exchanges reacting to these moves. Other work has identified Binance's perpetual market as the primary source of price formation across the crypto landscape. While the evidence is not conclusive, with some studies finding that spot markets still lead at certain frequencies or during times of stress, the overall direction of research points to the derivatives market as the primary driver of price discovery. The funding rate, which is paid by the crowded side of the trade every few hours, serves as a tether that keeps the contract price anchored to the underlying asset and provides a live readout of market sentiment. Traders closely watch the funding rate, as it can provide valuable insights into market sentiment. The influence of perpetual futures was recently demonstrated in the case of SpaceX's IPO, where traders on crypto exchanges were able to accurately price the company's valuation before its public listing. The perpetual market was able to predict the first-day demand for SpaceX's stock more accurately than traditional banks, highlighting the power of derivatives markets in price discovery. However, the perpetual market's limitations were also exposed, as it was unable to account for the supply of locked-up insider shares that became eligible to sell after the IPO, leading to a significant decline in the stock price. This example illustrates the importance of understanding the role of perpetual futures in the crypto market and their potential applications in traditional markets.