What is the funding rate for a perpetual contract? How to use it?

The funding rate, calculated based on supply and demand, price difference, and interest rates, reflects market sentiment and presents opportunities for strategic trading, such as carry trading and mean reversion trading.

Feb 26, 2025 at 11:43 am

Key Points

• Definition of Funding Rate
• Calculation of Funding Rate
• Factors Influencing Funding Rate
• Using Funding Rate to Determine Market Sentiment
• Strategies to Profit from Funding Rate

What is the Funding Rate for a Perpetual Contract?

A funding rate is a periodic payment made between traders holding long and short positions in a perpetual contract. It is designed to maintain the price of the perpetual contract in line with the spot price of the underlying asset. The funding rate can be positive or negative.

How to Calculate the Funding Rate:

The funding rate is typically calculated every 8 hours and is determined by the following factors:

• Difference between the perpetual contract price and the spot price. If the perpetual contract price is trading at a premium to the spot price, the funding rate will be positive. Conversely, if the perpetual contract price is trading at a discount to the spot price, the funding rate will be negative.
• Interest rate differential between long and short positions. The funding rate also takes into account the interest rate differential between the perpetual contract and the spot market. This is because buyers of the perpetual contract must pay interest to sellers, while sellers of the perpetual contract receive interest from buyers.

Factors Influencing the Funding Rate:

Several factors can influence the funding rate, including:

• Supply and demand for the perpetual contract. High demand for the perpetual contract relative to supply can lead to a positive funding rate, while low demand relative to supply can lead to a negative funding rate.
• Volatility of the underlying asset. Increased volatility can result in a wider spread between the perpetual contract price and the spot price, leading to larger funding payments.
• Market sentiment. Bearish sentiment can drive the perpetual contract price below the spot price, resulting in a negative funding rate. Conversely, bullish sentiment can push the perpetual contract price above the spot price, resulting in a positive funding rate.

Using the Funding Rate to Determine Market Sentiment:

The funding rate can provide insights into market sentiment. A positive funding rate generally indicates that most traders expect the underlying asset price to rise. Conversely, a negative funding rate suggests that most traders expect the underlying asset price to fall.

Strategies to Profit from the Funding Rate:

Traders can use the funding rate to develop strategies to profit. Some common strategies include:

• Carry trading: Holding a long position when the funding rate is positive and a short position when the funding rate is negative.
• Mean reversion trading: Opening a position in the direction opposite to the current funding rate, betting that the perpetual contract price will mean revert to the spot price.
• Hedging: Using the funding rate to adjust their portfolio to reduce risk.

FAQs:

• What happens when the funding rate is negative? When the funding rate is negative, long positions pay short positions. This encourages traders to close their long positions, which can drive the perpetual contract price down.
• How can I use the funding rate to gauge market sentiment? A positive funding rate generally indicates that traders are bullish, while a negative funding rate suggests that traders are bearish.
• Can I make money from the funding rate? Yes, traders can use strategies such as carry trading and mean reversion trading to profit from the funding rate.
• What is the difference between a positive and negative funding rate? A positive funding rate means that long positions pay short positions, while a negative funding rate means that short positions pay long positions.
• How often is the funding rate calculated? The funding rate is typically calculated every 8 hours.