What is Funding Rate?
Funding rates are periodic payments either to traders that are long or short based on the difference between perpetual contract markets and spot prices. Therefore, depending on open positions, traders will either pay or receive funding.
When the market is bullish, the funding rate is positive and tends to rise over time. In these situations, traders who are long on a perpetual contract will pay a funding fee to traders on the opposing side. Conversely, the funding rate will be negative when the market is bearish, where traders who are short on a perpetual contract will pay a funding fee to long traders.
Why Is the Funding Rate important?
The funding rate is primarily used to force convergence of prices between the perpetual contract and the underlying asset.
Unlike traditional futures, perpetual contracts have no expiration date. Thus, traders can hold positions to perpetuity unless he gets liquidated. As a result, trading perpetual contracts are very similar to spot trading pairs.
As such, crypto exchanges created a mechanism to ensure that perpetual contract prices correspond to the index. This is known as Funding Rate.
How to calculate Funding Rate?
The funding rate consists of two parts: Interest Rate and Premium Index.
ONUS Pro calculates the Interest Rate (I) and Premium Index (P) every minute, and then performs an N*-Hour Time-Weighted-Average-Price (TWAP) over the series of minute rates. The Funding Rate is next calculated with the N*-Hour Interest Rate component and the N*-Hour premium / discount component. A +/−0.15% dampener is added
N* = Funding Time interval. If funding occurs once every 8 hours, N = 8. And if funding occurs once per hour, N = 1.
Hence, if (I − P) is within +/−0.05%, then F = P + (I − P) = I. In other words, the funding rate will equal the Interest Rate.
This calculated funding rate is then applied to a trader’s position value to determine the funding fee to be paid or received at the funding timestamp.
What determines the Funding Rate and more information you need to know.
Interest Rate (I)
Let’s take BTCUSDT as an example
Every contract traded on ONUS Pro comprises a base currency, such as USDT, and a quoted currency, such as BTC. The interest rate is a function of the difference in interest rates between these two currencies. In this case, this is the difference between the borrowing costs of USDT and BTC.
Funding time interval: 3 = 24/8 (assuming funding time intervals occur every 8 hours)
Interest Quote Index = 0.03%
Interest Base Index = 0.06%
This is based on the following calculation:
Interest Rate = [ABS (0.03% − 0.06%)]/3 = 0.01%
Premium Index (P)
Perpetual contracts may trade at either a premium or discount from the mark price. In this situation, a premium index will be used to raise or lower the next funding rate to align with the level of the contract trade.