Understanding the Funding Rate

Funding rates are periodic payments made between traders who hold long (buy) and short (sell) positions in a perpetual futures market. They can be either positive or negative, depending on how the perpetual contract price compares to the spot price of the underlying asset.

When the price of a perpetual futures contract diverges from the spot price, the funding rate incentivizes traders to take positions that bring the prices back in line. Specifically:

  • When the funding rate is positive, traders with long positions pay fees to those with short positions.

  • When the funding rate is negative, traders with short positions pay fees to those with long positions.

How Funding Rates Work:

The funding rate is composed of two main elements: the interest rate and the premium index.

1. Interest rate

The interest rate reflects the cost of capital. In crypto trading, this typically represents the difference in borrowing costs between the base currency (such as USD) and the quote currency (such as BTC). This rate is usually small and relatively stable.

2. Premium index

The premium index measures the difference between the perpetual contract price and the spot price of the underlying asset.

  • A positive premium indicates that the perpetual contract price is higher than the spot price, showing strong buying interest.

  • A negative premium indicates that the perpetual contract price is lower than the spot price, showing strong selling interest.

Funding Rate Calculation

The funding rate is calculated using the interest rate and the premium index, although the exact formula can vary between exchanges. It's crucial to understand how the funding rate is calculated on your chosen exchange to manage your trading risks effectively.

Example

Binance Futures uses a fixed interest rate model, assuming that holding cash equivalent assets generates higher returns than holding crypto assets. The default interest rate on Binance Futures is 0.03% daily, divided into three payments of 0.01% each (one every eight hours).

On Binance Futures, you can view the current funding rate and the countdown to the next payment at the top of the trading interface.

For detailed information on how funding rates are calculated on Binance Futures, you can refer to their official FAQ page.

Learn more: What Are Funding Rates in Crypto Markets?