What does funding rate mean?
If you are new to cryptocurrency perpetual contract trading, do you often hear the concept of "funding rate"? What exactly does funding rate mean? Why does it affect contract transactions?
Before understanding funding rates, we need to know how cryptocurrency perpetual contracts work.
Cryptocurrency perpetual contracts (or perpetual futures) are a derivative contract through which investors can go long (buy up), short (buy down) and arbitrage, unlike traditional futures with fixed expiration dates. Differently, the biggest feature of perpetual contracts is that they can be held indefinitely.
In order to keep the perpetual contract price close to the spot price, the cryptocurrency exchange BitMEX proposed the concept of funding rate to check and balance the transactions between buyers and sellers.
It should be noted that the funding fee is not charged by the exchange, but paid to other investors who are long or short on the same exchange. When you hold a perpetual contract position, you will pay or receive funding fees every 8 hours. The calculation method of funding fees is related to the funding rate, which will be introduced in detail below.
How to calculate funding rate?
According to the BitMEX exchange, the funding fees and funding rates for cryptocurrency perpetual contracts are calculated as follows:
Funding fee = Position value X Funding rate. Where position value = contract quantity / mark price.
Funding rate = premium index (P) + interest rate component (clamp)
Note: The actual formula is more complicated, so I won’t go into details in this article. If you are interested, you can read the introductions of major exchanges.
For ordinary investors who are not majoring in finance, the above formula only needs to be roughly understood. The concepts we need to understand are:
Funding fees are paid or charged every 8 hours
Funding fee = Position value X Funding rate
If the calculation is positive, it means that long sellers will pay a fee to short sellers.
If the calculation is negative, the short seller pays a fee to the long seller
If you still can’t understand it, (CryptoCity) has compiled a super easy-to-understand teaching diagram to help you understand the funding rate at once!
Image source: Crypto City Production What are the funding fees and funding rates?
Picture source: Crypto City Production Funding Fees and Funding Rate Operation Methods
Image source: Crypto City Production How to calculate capital costs
Recommended Funding Rate Calculator
The funding rate will fluctuate with the real-time premium and interest rate of the exchange, and complex mathematical formulas are involved behind it. Therefore, there is currently no accurate funding rate calculator on the market, but there are calculators for perpetual contracts. Users only need to enter Based on the corresponding information, you can estimate the income, return on investment, forced liquidation (liquidation) point, etc.
If you want to calculate the Binance contract income, you can use the official contract calculator. After selecting the name of the perpetual contract for the transaction, enter the opening price, closing price, transaction quantity, and drag the leverage multiple you used, and then Just click "Calculate".
How to check the funding rate? Take the Binance Bitcoin contract funding rate as an example
As for the funding rate, what do you think? In fact, most exchanges will directly list the current funding rate. The following uses the Binance Bitcoin contract funding rate as an example to teach the query steps:
Step 1: Enter the Binance BTC/USDT perpetual contract page
Step 2: You can see the current funding rate in the upper right corner
Step 3: After clicking on the funding rate, you can view the historical funding rate record
Picture source: Crypto City Production Binance Bitcoin Perpetual Contract Funding Rate Inquiry Tutorial
How to arbitrage the funding rate?
Since there will be a slight difference between the spot and perpetual contract prices of cryptocurrencies, and the funding rates for the same perpetual contract trading pair (for example: BTC/USDT) on each exchange are different, there is room for arbitrage.
Currently, there are two common methods of funding rate arbitrage in the cryptocurrency industry:
1.Trade spot and perpetual contracts at the same time
According to Binance Exchange’s instructions, users can hedge the risk of price changes by simultaneously trading spot and perpetual contracts while earning funding fee income. The specific operation method is as follows:
When the funding rate is positive: traders obtain stable funding fee income by buying and shorting equivalent-valued perpetual contract positions in the spot market, which is called forward arbitrage.
When the funding rate is negative: traders earn stable profits by "shorting" in the spot market (usually borrowing assets and selling them at the current price) and "going long" in the perpetual contract with equivalent leverage positions. Funding fee income.
However, it is somewhat difficult for traders to always pay attention to changes in funding rates and make corresponding arbitrage operations in real time. Therefore, some mainstream exchanges such as Binance and OKX have now launched "funding rate arbitrage robots" to continuously use changes in funding rates to arbitrage in an automated way.
How to use Binance Funding Rate Arbitrage Robot?
If you want to use Binance's funding rate arbitrage robot, you can find the page in the order of "Contracts" > "Robots" > "Arbitrage Robot", and then select the strategy you want to use.
Source: Crypto City Production Binance Fund Rate Arbitrage Robot Tutorial
2. Hold equal amount of contract hedging orders on different exchanges
Since the funding rates for the same trading pair on each exchange are different, we can open hedging orders for equal amounts of contracts on two exchanges at the same time to earn the "price difference" in the funding rates between the two exchanges.
To put it simply, assuming that the perpetual contract funding rate of the Binance BTC/USDT trading pair is 0.01%, and the funding rate of the same trading pair on OKX is -0.01%, which means that their funding rates differ by 0.02%, then the user You can go short on Binance and long on OKX, and hold hedging orders of equal size respectively.
In this way, after closing the positions at the same time, the profits and losses of the two orders will offset each other, and you can also earn additional funding rate income.
How will funding rates affect the market? How do I read the funding rate?
The funding fee calculated based on the funding rate will affect the cost/income of cryptocurrency perpetual contract traders. If you are the party paying the funding fee, you need to measure how long you want to hold your contract order.
In addition, since the funding rate is calculated based on the long and short transactions in the perpetual contract market, it can also be used to judge market sentiment. The judgment method is as follows:
When the funding rate is positive
When the funding rate is positive, it means that longs have to pay funding fees to shorts. This reflects that the market sentiment of the perpetual contract is optimistic, and there are more long orders than short orders.
When the funding rate is negative
When the funding rate is negative, it means that short sellers have to pay funding fees to long sellers. This reflects that the market sentiment of the perpetual contract is pessimistic, and there are more short orders than long orders.
The funding rate exceeds a certain value
Blockchain data platform CoinGlass notes that, generally speaking, Bitcoin funding rates are capped at 0.375% and -0.375% at the lowest level, while there may be some differences between exchanges.
If the 8-hour real-time funding rate exceeds 0.01%, it means that the perpetual contract market is currently in a high funding rate state. When funding rates remain high for a long time, it may lead to an unsustainable surge in perpetual contract prices, which may trigger a correction or even a collapse.
