The Dominance of Perpetual Futures in Crypto Markets and Beyond

The process of setting cryptocurrency prices is often misunderstood, with many believing it is driven by spot trading. However, perpetual futures contracts have become the dominant force in determining crypto prices, accounting for approximately 93% of all crypto futures volume. These contracts, which can be held indefinitely, have been shown to lead price discovery, with research indicating that they are the primary source of new information in the market. A study published in the Journal of Financial Markets found that perpetual swaps on unregulated venues were the strongest instruments for bitcoin price discovery, while other work has identified Binance's perpetual market as the primary source of price formation. The evidence suggests that the derivatives market is where prices are made, with spot markets reacting to moves in the derivatives market. The funding rate, which is the cost of holding a perpetual contract, plays a crucial role in maintaining the contract's price and is closely watched by traders as a gauge of market sentiment. The use of perpetual futures contracts to predict the valuation of SpaceX prior to its initial public offering (IPO) is a notable example of their influence. Traders on platforms such as Binance and Coinbase were able to buy and sell exposure to SpaceX through pre-IPO perpetual futures, which accurately predicted the company's stock price on its first day of trading. The success of these contracts in predicting the stock price highlights the growing importance of the derivatives market in price discovery, not just in crypto but also in traditional assets. The fact that perpetual futures contracts are excellent at pricing demand but blind to supply is an important consideration, as it can lead to significant price movements when supply and demand are out of balance.