Funding rates

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On crypto markets perpetual futures or perps are contracts that never expire. You can buy as many perpetual futures as you like, you won’t ever take delivery of the underlying cryptocurrency. Therefore, there needs to be some other mechanism to ensure the perpetual future trades as close to the spot price as possible.

The exchanges use a mechanism called funding, a payment between those who have gone long on the perp and those who have gone short, to ensure that the perpetual prices converge to spot.

Exchanges will track the spread between the spot prices and the perpetuals, and use this to determine the funding rate.

The payment depends on whether the spread between futures and spot is positive (perpetuals above spot) or negative (perpetuals below spot):

  • Positive spread: Traders who are long pay funding to traders who are short

A positive spread indicates that there are more long positioned traders, willing to pay funding to short traders.

  • Negative spread: Traders who are short pay funding to traders who are long

Negative funding rates indicate that there are more short positioned traders, willing to pay funding to long traders.

The size of the spread determines the size of the payments. A larger spread means a larger payment, and more incentives for traders to collect funding and push perpetuals closer to spot. The most common trade that takes advantage of funding is called funding rate arbitrage: Traders will sell (buy) perpetuals to collect funding payments to shorts (longs), while buying (selling) the spot coin to hedge the coin risk they take.

Essentially, funding rates are designed to encourage traders to take positions that keep perpetual contract prices line in with spot markets.

See More

Funding rates: A beginners guide by Juiced


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