What is the rate of a perpetual contract?

The funding rate, a periodic payment made between long and short traders in perpetual contracts, aims to align the contract's price with the underlying spot market, promoting price convergence and reflecting market sentiment.

Oct 23, 2024 at 01:54 am

Understanding the Rate of a Perpetual Contract

Perpetual contracts are financial instruments that allow traders to take long or short positions on the price of an underlying asset, such as cryptocurrency, commodities, or indices. Unlike traditional futures contracts, perpetual contracts do not have an expiry date and can be held indefinitely.

Concept of Funding Rate

The rate of a perpetual contract is commonly referred to as the "Funding Rate." It is a periodic payment made between traders who are long (bullish) and short (bearish) on the contract. The purpose of the funding rate is to maintain the price of the perpetual contract close to the price of its underlying index or spot market.

Calculation of Funding Rate

The funding rate is calculated based on the following factors:

1. Premium/Discount: The difference between the perpetual contract price and the underlying index or spot market price.
2. Cost of Carry: The interest rate differential (basis) between two currencies or assets involved in the perpetual contract.
3. Trading Fees: Transaction fees paid by traders to enter or exit a perpetual contract position.

Method of Payment

The funding rate is paid or received every 8 hours (typically at 00:00, 08:00, 16:00 UTC). Traders who hold long positions pay a funding rate to traders who hold short positions if the perpetual contract price is higher than the underlying index or spot market price. When the reverse is true, short traders pay the funding rate to long traders.

Effect of Funding Rate

1. Convergence: The funding rate encourages long traders to sell when the perpetual contract price rises above the underlying index, and short traders to buy when it falls below. This helps keep the contract price close to the underlying market price.
2. Market Sentiment: A positive funding rate indicates that more long traders are paying the rate, suggesting bullish sentiment in the market. Conversely, a negative funding rate indicates bearish sentiment.
3. Profit/Loss: Traders can profit or lose from funding rate payments depending on their position and the funding rate itself.

Example

Suppose the perpetual contract price for Bitcoin (BTC) is $25,000, while the spot market price is $24,900. The funding rate in this case is positive, indicating that traders with long positions are paying traders with short positions. This encourages some long traders to close their positions, pushing the perpetual contract price closer to the spot market price.