Ah – a perpetual swap (perp) doesn't actually settle like a futures contract does. It is purely a synthetic instrument that tracks the price of the underlying instrument (Tether, in this case). The contract technically does not settle (hence the "perpetual") and is priced constantly. There is no moment at which an exchange determines a settlement price because no Tether is held for the sake of delivery.
You may be wondering how the price of the perp tracks the price of the asset if there is no underlying asset to moor the price to? It's done through what's called a funding rate. Basically, there are two prices relevant to a perp contract: the price of the perpetual contract on the exchange and the price of a reference index that is meant to accurately represent the price of the asset on a fiat exchange.
The price of the perp should follow the index price, but there are often deviations. That's where the funding rate kicks in. To moor the price of the perp to the price of the underlying asset, traders pay/receive a funding rate (think of it like an interest rate) every x number of hours (x is determined by the exchange).
If the contract price is higher than the index price, that indicates there is excess demand for the contract on the exchange and, thus, traders who are long the contract have to pay a funding rate to those that are short the contract. That is because the system is trying to incentivize traders to sell (short) the perp in order to move the price down, in line with the reference index. The further the perp price deviates from the index, the higher the funding rate. If the price of the perp is below the index price, the funding rate flips negative. That means that those who are short the contract have to pay a funding rate to those that are long, thereby creating incentive for people to buy the perp and raise the price.
My question is what is that reference index? Tether is so large that the reference can’t be any of the big established crypto exchanges because they might be incentivized to “halt trading” to let the market “stabilize” rather than actually let it breakdown.
If there was a run on tether and exchanges shut down trading, I cannot imagine that making the situation any better. Traders would just move off exchange to some place where there's actual liquidity. Moreover, traders would never use that exchange again. Halting would do nothing like it does in traditional markets. In crypto, price discovery cannot be stopped.
In regards to those pairs being used as reference prices, there's no chance they freeze prices just to stabilize the derivatives. Open interest on tether is only $328m on $73b Tether outstanding
You may be wondering how the price of the perp tracks the price of the asset if there is no underlying asset to moor the price to? It's done through what's called a funding rate. Basically, there are two prices relevant to a perp contract: the price of the perpetual contract on the exchange and the price of a reference index that is meant to accurately represent the price of the asset on a fiat exchange.
The price of the perp should follow the index price, but there are often deviations. That's where the funding rate kicks in. To moor the price of the perp to the price of the underlying asset, traders pay/receive a funding rate (think of it like an interest rate) every x number of hours (x is determined by the exchange).
If the contract price is higher than the index price, that indicates there is excess demand for the contract on the exchange and, thus, traders who are long the contract have to pay a funding rate to those that are short the contract. That is because the system is trying to incentivize traders to sell (short) the perp in order to move the price down, in line with the reference index. The further the perp price deviates from the index, the higher the funding rate. If the price of the perp is below the index price, the funding rate flips negative. That means that those who are short the contract have to pay a funding rate to those that are long, thereby creating incentive for people to buy the perp and raise the price.