What Are Funding Rates and How Do They Work in Crypto Futures?

What Are Funding Rates?

Funding rates are payments between traders who trade crypto futures. A crypto future is a contract that lets you speculate on a rise or fall in the price of a cryptocurrency without having to buy the crypto itself. Think, for example, of a contract on the price of Bitcoin.

A perpetual future does not have a fixed end date. That means you can keep such a position open for longer.

To make sure the price of a perpetual future does not drift too far away from the spot price of the cryptocurrency, funding rates are used.

Simply put: traders with a long position, who are betting on a price increase, and traders with a short position, who are betting on a price drop, pay funding to each other at fixed times. If the funding rate is positive, longs usually pay shorts. If the funding rate is negative, shorts usually pay longs.

Because there is no end date, the price of a perpetual contract can start to move away from the regular price on the spot market. The spot price is simply the price at which you buy or sell crypto directly at that moment. Funding rates are there to keep the contract price closer to that spot price, or to an index price.

A funding rate is a percentage. What you ultimately pay or receive also depends on the notional value of your position, which is the total value of your position in the market. So it is different from the trading fees you pay when you open or close an order. With funding, traders with opposite positions exchange the payment with each other.

Important to know: funding rates apply to perpetual futures. Regular futures with a fixed expiration date do not automatically use the same periodic system.

Key Takeaways

• Funding rates are periodic payments between long and short positions in perpetual futures.
• Perpetual futures do not have a fixed expiration date.
• Funding helps keep the price of a perpetual contract closer to the spot or index price.
• The payment depends on both the funding rate and the notional value of your position.
• Funding is different from the fees for opening or closing a trade.

How Do Funding Rates Work in Crypto Futures?

The direction of the funding rate is largely determined by the difference between the perpetual price and the spot or index price. If the perpetual contract trades above that reference price, the funding rate is usually positive. Then longs pay shorts.

That makes it more expensive to hold a long position. At the same time, a short position becomes more attractive because of the possible funding payment. That incentive can help move the contract price back toward the spot price.

If the contract trades below the reference price, the funding rate is usually negative. In that case, shorts pay longs. That makes it relatively more expensive to stay short.

Funding is settled at fixed times, also called settlement moments. A crypto exchange might settle every hour, while other contracts often use an eight-hour interval. The exact interval can differ by contract and market conditions.

On many platforms, you only pay or receive funding if your position is still open at the settlement moment. If you close the position before that time, you usually do not pay or receive anything for that funding moment.

Also watch out for a displayed or estimated rate. It can still change before the actual settlement happens. Positive funding also does not automatically mean the crypto market is rising, and negative funding does not automatically mean the market is falling. It mainly has to do with the relationship between the perpetual price and the reference price being used.

How Are Funding Rates Calculated?

The basic idea is pretty simple: a crypto exchange compares the price of the perpetual contract with a spot or index price. If the contract price is above that reference, that usually leads to positive funding. If the price is below it, negative funding is more likely.

You can roughly calculate the actual payment like this:

funding payment = notional position value × funding rate

The notional position value is simply the total market value of your position. Say your position has a notional value of €10,000 and the funding rate for one interval is 0.01%. Then the funding payment is €1. If you are on the paying side, you pay €1. If you are on the receiving side, you receive €1.

In practice, there is often more going on behind the scenes. For example, a crypto exchange may work with a premium index, an interest component, and limits on how high or low the rate can go. Those limits are called caps and floors.

A platform may also average price differences over a certain period so that one short price spike has less impact. Some systems also carry part of the previous funding rate into the new calculation. That is how they try to slow down big, sudden jumps.

So there is no universal formula that works exactly the same everywhere. For an exact calculation, always check the rules of the contract you are trading. The index used, mark price, limits, and funding interval can differ and can change.

Who Pays the Funding Rate and Who Receives It?

With positive funding, longs pay shorts, and with negative funding, shorts pay longs. The side that has to pay must have an open position at the settlement moment. The other side then gets a credit according to the platform's rules.

Example: You have a long position with a notional value of €5,000. If the funding rate is positive and is 0.02%, you pay €1 for that interval. If someone has a short position with the same notional value, that person may receive that funding.

The funding payment usually does not go to the crypto exchange as a standard fee. In many cases, the amount is settled between traders with a long and short position.

Exactly how this happens depends on the platform's clearing model. Simply put, that is the way an exchange keeps track of who has to pay, who receives money, and how that amount is ultimately processed in the accounts. Because of that, processing can differ by platform or contract.

The main rule to remember is: always look at the sign of the funding rate. Positive does not always mean you pay, because that depends on whether you are long or short.

How Do Funding Rates Affect Your Trading Costs and Position?

Funding can increase or reduce your final result, on top of price gains or losses and separate from maker and taker fees. Especially if you keep a perpetual position open for longer, multiple funding moments can add up quite a bit.

The size of the funding payment depends on the size of your position. If you have a €20,000 position, then the funding payment at the same funding rate is twice as large as for a €10,000 position. That applies to both paying and receiving.

Leverage does not change that calculation. Funding is still calculated on the total value of your position. But leverage can make the funding hit your own money harder.

With leverage, you use relatively little of your own money to open a larger position. The amount that has to stay available to keep your position open is called margin. Because of that, a funding payment can take a bigger chunk out of your available margin.

Say you keep a large leveraged long position open through several funding moments while the funding rate is positive. Then you keep paying funding each time. As a result, your available margin can keep getting lower.

If your available margin gets too low to meet the platform's requirements, your position can be liquidated. The platform then closes the position automatically.

That is why funding risk is especially important for large leveraged perpetual positions that you keep open for a longer time. The funding rate can also change in size and even in direction. So do not think of funding as a fixed cost or fixed return.

In practice, before you open a position, it is smart to check at least these points:

• the current funding rate;
• the next settlement moment;
• the notional value of your position;
• how often the contract settles funding;
• how much margin you will have left if you have to pay funding.

Conclusion

Funding rates are the mechanism that tries to keep perpetual futures closer to the spot or index price. If funding is positive, longs pay shorts. If funding is negative, shorts pay longs.

For a short trade, the impact may be small, but with a large position, leverage, or multiple settlement moments, funding can add up a lot. So do not just look at the price where you enter. Also check the current funding rate, the next settlement moment, and how much margin your position still has.