TL;DR
In crypto, funding rate is a tool that keeps the futures market price in line with the actual asset's price.
If the funding rate is positive, people who bet on the price going up (long positions) pay a fee to those who bet on it going down (short position).
If it's negative, it's the other way around.
Funding Rate Explained
Futures trading in a traditional market involves buying and selling contracts. These contracts involve parties committing to buying and selling a digital asset at a predetermined price on a specified future date, hence the name.
This trading method provides traders with the opportunity to speculate on the future price movements of cryptocurrencies without the necessity of owning the underlying assets.
In crypto, the type of futures contracts you engage with every day operates a bit differently, in the sense that it specifies no expiration date. The contract terms, including both benefits and liabilities, just keep concluding and evolving continuously, perpetually. Indeed, this particular type is called perpetual contracts.
To balance traders favoring one side in such a continuous manner, perpetual contracts employ a funding rate mechanism. This mechanism helps to maintain the contract's price close to the spot market by incentivizing traders to rebalance positions. But why is such a mechanism necessary?
The Importance of Funding Rate
Expiration dates in traditional futures contracts, not in crypto, are designed to keep the contracts’ prices close to the spot market.
These expiration dates first serve as clearing mechanisms, effectively resetting the market's obligations for a new start.
Another approach to maintain the proximity of futures contract prices to the spot market in traditional futures contracts is through arbitrage. Arbitrageurs, who do arbitraging, capitalize on price differences between the futures and spot markets.
For instance, when the futures contract price is higher than the spot market, arbitrageurs sell the overpriced contracts to profit from the price differential, and conversely, when the futures contract price is lower, they buy the contracts. This buying or selling activity helps realign the futures contract price with the spot market.
For perpetual futures contracts without expiration dates, the funding rate mechanism plays a comparably crucial role. The funding rate is a mechanism that involves periodic cash flows exchanged between long and short position holders in futures contracts. These cash flows are determined based on the difference between perpetual futures and market (spot) prices.
When there are more traders expecting a cryptocurrency's price to rise (the "Longs") than those betting on it to fall (the "Shorts"), the futures contract price tends to be higher than the current market price. To balance this, exchanges that provide perpetual futures contracts charge a POSITIVE funding rate, where Long traders pay Short traders at set intervals, prompting some to reconsider their positions and aligning the futures price with the market.
Conversely, when there are more Short traders expecting a token’s price to decline, the price falls below the market, and the exchange applies a NEGATIVE funding rate, aligning the price by having Short traders pay Long traders. And the vicious cycle starts again.
Case Study: $TRB Futures
Let's delve into the historical funding rates of TRB on Binance around September 2023.
In details:
The TRB price on the spot market soared from $15.15 to $52.67, while the Funding Rate hit its lowest point at -2.8%, aligning with an impressive surge of over $850 million in open interest volume within the TRBUSDT trading pair alone.
After such highs, the market would typically expect a price drop as correction. And that was exactly what happened when $TRB reached $45 on September 16. Many investors opted for a Short position on $TRB, resulting in a notably high funding rate, nearly -3%.
However, some chose a Long position for a couple of reasons. First, they may have believed in further price gains, and second, Long positions enable them to earn fees from Short positions.
For instance, if Person A Shorted $TRB for $1000 and Person B went Long with the same amount, at a funding rate of -3%, A would need to pay 3% of the $1000 to B, which amounts to $30. Those in Short positions must compensate those in Long positions until the funding rate returns to the balancing point, with neither sides having the upper hand.
Keep in mind that investors in Long positions in this example do not essentially make profits here if:
their positions are liquidated, meaning they lose all the money they bet on the contract
their positions are near the liquidation point and the funding rate payment is unable to make up for the loss they have suffered.
A quick note: On Binance, contract funding fees (future rate payment) are typically charged every 8 hours, requiring one side to pay a funding rate to the opposite side exactly after each 8-hour. However, for certain perpetual contracts, the settlement frequency was reduced from every 8 hours to 4 hours, starting from October 12th.
This strategic adjustment significantly contributed to reestablishing the balance between Short and Long positions, effectively standardizing the funding rate. Meanwhile, some traders have playfully referred to it as a "funding trap”.
And take note that these contract funding fees are static, which means the exchanges charge you at exactly the hours written here (mind the timezone difference!), no matter when your position is open.
How to Monitor Funding Rates Effectively
There are a few tools that allow you to follow funding rates in real time.
If you only trade perpetuals of one token on one exchange at a time, and need to see funding rates along with other relevant metrics while trading, use Coinglass.
What if you want to trade futures on more than one tokens on more than one exchanges? Go to m3talab.io to:
view funding rates of the same token on up to 11 exchanges
compare spot price VS. futures price
get a (Beta) predicted funding rate of each token
Remember prediction algorithm is always subject to inaccuracy; Trade with caution!
What if you want to find a token that is gaining the highest or lowest funding rate across exchanges? We’ve got you:
Find the top 10 Long and Short tokens across all 11 exchanges in the past 24hrs.
Find 10 tokens are being Shorted and Longed the most on each exchange in the past 24hrs.
Find the next futures alpha!
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