Funding Rate

Funding is a payment made from one side of the trade (long or short) to the other. Negative Funding Rate: Short perpetual positions pay longs. Positive Funding Rate: Long perpetual positions pay shorts.

What is Funding Rate

Funding is a payment made from one side of the trade (long or short) to the other. When the funding rate is negative, shorts pay longs, when funding is positive longs pay shorts.

When the price of the perpetual swap is lower than the index, then in order to strengthen demand for longs and subsequently encourage the price to increase towards the index, longs are paid funding by shorts (negative funding). This has the effect of decreasing demand for shorts and increasing demand for longs until the price approaches the index again.

Conversely, when the price of the perpetual swap is higher than the index, then in order to strengthen demand for shorts and subsequently encourage the price to fall towards the index, shorts are paid funding by longs (positive funding). This has the effect of decreasing demand for longs and increasing demand for shorts until the price reaches the price of the index.

Why Funding Rate Exists

The funding mechanism serves to keep the Perpetual price in the exchange in line with the spot prices.

Unlike conventional futures, perpetual futures traders can hold positions without an expiry date and do not need to keep track of various delivery months.

For instance, a trader can keep a short position to perpetuity unless he gets liquidated. As a result, trading perpetual contracts are very similar to trading pairs on the spot market.

Since perpetual futures contracts never settle in the traditional sense, exchanges need a mechanism to ensure that futures prices and index prices converge on a regular basis. This mechanism is also known as Funding Rate.

Zero Sum Game

Funding is a zero sum game, where longs receive all funding from shorts, or shorts receive all funding from longs. The further away from the index the price of the perpetual gets, the larger the funding rate becomes. Some exchanges expressed their perpetual funding rate as per 8-hour interest rate.

The funding rate is based on two components: the interest rate and the premium. The interest rate may change from one exchange to another, and the premium varies according to the price difference between futures and spot markets.

Interpreting Funding Rate

While not imperative, Funding Rate is an indicator for the market sentiment or willingness to stay biased in direction.

• > 0 (Positive rates): Overall Long Sentiment

  Positive funding rates indicate that long perpetual traders are dominant and are willing to pay funding to short traders. Positive funding rates imply that many traders are bullish.

• < 0 (Negative rates): Overall Short Sentiment

  Negative funding rates indicate that short perpetual traders are dominant and are willing to pay to long traders. Negative funding rates imply that many traders are bearish.