What are the basic principles of the funding rate in the cryptocurrency market?

Concept of funding rate

The funding rate is an important indicator in the cryptocurrency perpetual futures market. This mechanism refers to the fees that occur regularly between traders holding long and short positions. The funding rate takes a positive or negative value based on the relationship between the price of the perpetual contract and the spot price of the underlying asset.

Funding Rate Mechanism

When the price of perpetual futures contracts deviates from the spot price, the funding rate encourages traders to take positions that bring the price back to its original level. Specifically, in the case of a positive funding rate, funds flow from long positions to short positions, while in the case of a negative funding rate, funds flow from short positions to long positions.

Funding Rate Components

The funding rate is mainly composed of two factors: the interest rate component and the premium index. The interest rate component reflects the cost of capital and usually represents the difference in borrowing costs between the base currency and the quoted currency in cryptocurrency trading. This rate tends to be comparatively small and stable. On the other hand, 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 (strong buying demand), while a negative premium indicates that the perpetual contract price is lower than the spot price (strong selling demand).

Funding Rate Calculation Method

The calculation of the funding rate uses interest rate factors and premium indices, but the specific formula may vary depending on the trading platform. To effectively manage risk, it is important to understand how the funding rate is calculated on the platform you are using.

Some major cryptocurrency trading platforms assume that holding cash-equivalent assets yields higher returns than holding cryptocurrencies, and thus adopt a fixed interest rate model. For example, a default interest rate of 0.03% per day is set, and payments are made in three installments of 0.01% every 8 hours. In many cases, the current funding rate and a countdown to the next payment are displayed on the trading interface, allowing traders to easily check the information.