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Demystifying Funding Rates: A Comprehensive Guide to Perpetual Swaps visualisation

Demystifying Funding Rates: A Comprehensive Guide to Perpetual Swaps

Explore funding rates and understand how perpetual swaps operate in the crypto landscape.
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Image source: Perpetual Contracts Guide | Delta Exchange - User Guide & Rule Book

Perpetual swaps (perps) are crypto derivatives that let you hold leveraged long or short positions without an expiry date, using funding rates to keep their price anchored to the underlying spot index. 1, 4

What is a funding rate?

The funding rate is a periodic payment exchanged directly between traders (not the exchange) that incentivizes the perp price to converge with the spot price: 8, 1

ScenarioPerp Price vs. SpotFunding RateWho pays whom?Purpose
Perp > SpotHigher (Bullish)PositiveLongs → Shorts 1Encourage shorts, cool down price
Perp < SpotLower (Bearish)NegativeShorts → Longs 1Encourage longs, lift price
Perp ≈ SpotWithin ±0.025%ZeroNo payment 1No divergence to correct

The rate is typically quoted as an 8-hour interest rate (payments occur every few seconds but are proportional to this rate). 1

How the mechanism works

When perp price diverges from spot, the funding rate creates an economic incentive for traders to take the side that pushes prices back:

Diagram

Key details

  • Calculation: Funding rate = Premium Rate (difference between mark price and index) ± dampener, capped at ±0.5% for BTC per 8 hours 1
  • Zero-sum: All funding is transferred peer-to-peer; exchanges charge no fee on funding 1
  • Advantage over spot: You get leverage and can short without borrowing the asset 4
  • Cost consideration: If funding rates stay high for long periods, they can outweigh trading profits 3

Funding rates are the “secret sauce” that makes perpetual swaps work without expiry dates. 2

References