What is the funding rate? Why is it important? 🤨
Today, the community friends were amazed by the high rates of GMT.
If you have a long position of 1 WU, you will have to pay a funding fee of 2-3% per day, approximately 200-300 USD, which means if the coin price doesn’t fluctuate, you will lose 200 USD 😔
👀 So let's start with 'Perpetual Futures'!
Jie's friends are getting ready to study on their benches now ☺️
1. Traditional futures vs. perpetual futures
A key feature of traditional futures contracts is the expiration date. Once the contract expires, the settlement process begins.
Traditional futures contracts are typically settled monthly or quarterly. Upon settlement, contract prices tend to align with spot prices, and all open positions expire.
Perpetual contracts are widely offered in cryptocurrency derivatives exchanges and are designed similarly to traditional futures contracts. However, perpetual contracts have one key difference.
Unlike traditional futures, traders can hold positions without an expiration date and do not need to track various delivery months. For example, traders can hold short positions indefinitely unless liquidated. Thus, trading perpetual contracts is very similar to trading in the spot market.
Because perpetual futures contracts never undergo traditional settlements, exchanges need a mechanism to ensure that futures prices and index prices converge regularly. This mechanism is also referred to as the funding rate. 👏
2. What is the funding rate?
The funding rate is periodically paid to long or short traders based on the price difference between the perpetual contract market and the spot price. Therefore, depending on open positions, traders will either pay or receive funding.
The cryptocurrency financing rate can prevent persistent price discrepancies between the two markets. This rate is recalculated several times a day - Binance Futures calculates it every eight hours.
On Binance Futures, the funding rate (highlighted in red) and the countdown to the next funding (highlighted in yellow) are displayed as follows:
As shown in the image - funding rates displayed on Binance contracts 👋
3. What determines the funding rate?
The funding rate consists of two main components: the interest rate and the premium.
In Binance contracts, the rate is fixed at 0.03% daily (0.01% for each funding interval), except for contracts like BNBUSDT and BNBBUSD, which have a rate of 0%. Meanwhile, the premium varies based on the price difference between perpetual contracts and the marked price.
During periods of high volatility, prices of perpetual contracts may differ from the marked prices. In such cases, premiums will increase or decrease accordingly.
Large price difference, high premium. Conversely, small premium results in small price difference.
When the funding rate is positive, the price of perpetual contracts is usually higher than the marked price. Therefore, long traders pay fees to short traders. Conversely, a negative funding rate means that shorts pay fees to longs.
Funding rates are point-to-point payments. Therefore, Binance does not charge funding fee costs, as funding rates occur directly between users. 👋
4. How does the funding rate affect traders?
Since the funding calculation takes into account the leverage used, the funding rate can significantly impact traders' profits and losses. In high-leverage situations, traders paying funding may suffer losses and be liquidated even in low volatility markets.
On the other hand, raising funds can be very profitable, especially in range-bound markets.
As a result, traders can devise trading strategies to take advantage of the funding rate, even profiting in low volatility markets.
Essentially, the funding rate is designed to encourage traders to take positions that align the price of perpetual contracts with the spot market.
5. Correlation with market sentiment
Historically, cryptocurrency financing rates are often related to the overall trend of the underlying asset.
The cryptocurrency market never sleeps. Therefore, arbitrage opportunities are always present. Binance Futures allows traders to quickly and easily switch between the spot market and the futures market, enabling them to take advantage of these opportunities.
In this way, inefficiencies between perpetual contracts and marked prices are eliminated through arbitrage, leading to a reduction in the price difference between the two. While extreme volatility may cause funding rates to spike occasionally, arbitrage traders quickly seize these opportunities. Therefore, the funding rate ultimately returns to its mean.
In exchanges with stricter arbitrage restrictions, financing rates tend to be higher. This is due to limitations on transferring between the spot and futures markets. For example, some exchanges limit the number of transfers that can be made in a day.
6. How are funding fees determined?
The funding rate determines which party of traders pays or receives the funding fees, as well as the percentage of the positions involved.
When the market is in a contract premium state, meaning contract prices are higher than spot prices, the funding rate is positive. In this case, long position traders in perpetual contracts will pay funding fees to short position traders.
Conversely, if the market is in a spot premium state, meaning contract prices are lower than spot prices, the funding rate is negative. In this case, short position traders in the perpetual contract will pay funding fees to long position traders.
7. How to check funding fees?
Funding fees: The amount that traders ultimately pay or receive during the funding period. You can check the funding fee history in the transaction history.
Funding rate: The rate that determines which party pays and the amount of funding fees. The funding rate is based on the price difference between the perpetual contract price and the underlying cryptocurrency spot price.
Funding fee upper/lower limit: The maximum funding fee that can be charged to traders during the funding period, especially when the funding rate is very high.
Funding interval time: The frequency at which traders pay funding fees to each other. Usually once every eight hours, but the interval may be shorter during significant market fluctuations.
Funding period: The fixed time at which funding fees are paid between traders. 👏
8. What impact does a high funding fee have?
High funding fees paid by traders can negatively impact their trading performance.
Reduced profits: If traders are the ones paying fees, high funding fees can reduce their profits, especially if they hold long positions. The higher the funding rate, the higher the funding fees, thus reducing overall profits. However, if traders are the ones receiving fees, then the funding fees will increase their profits.
Increased risk of forced liquidation: High funding fees can severely affect a trader's ability to maintain positions in the market. Funding fees are regularly deducted from the trader's margin balance, greatly reducing the margin balance required to maintain positions. If a trader does not have enough margin to pay the funding fees, it may result in forced liquidation.
9. Conclusion - Good at utilizing the funding rate
Cryptocurrency financing rates play an important role in the perpetual futures market. Most cryptocurrency derivatives exchanges adopt a financing rate mechanism to keep contract prices aligned with the index. These rates change with the bullish or bearish movements of asset prices and are determined by market forces.
Funding fee arbitrage can also be regarded as the most basic operation in the arbitrage industry.
Additionally, cryptocurrency financing rates vary across different exchanges - in some exchanges, these rates remain high.
In contrast, exchanges like @binance and @bitgetglobal, which allow smooth transitions between the spot and futures markets, make it easier for traders to engage in arbitrage. As a result, inefficiencies are quickly eliminated.