Trading basics
Decipher BTC Funding Rate - The Engine of Perpetual Futures
Beginner
2023-10-20 | 5m
The
cryptocurrency world is known for its complexity and innovation, and
Bitcoin futures is no exception. Of all the trivial and complex mechanisms behind
Bitcoin
futures trading, "funding rate" is one of the most crucial and mysterious. In this article, we'll unravel the concept of the funding rate in Bitcoin futures and explore how it operates.
Understanding Bitcoin futures
A key feature of traditional futures contracts is their expiration date, typically a month or a quarter. Whenever a contract expires, a process known as settlement begins. At the time of settlement, the contrac
t price will converge with the underlying's spot price, and all expired open positions will be closed.
Unlike conventional futures, perpetual futures allow traders to hold positions without an expiry date and, therefore, without settlement. For instance, a trader can keep a short position to perpetuity unless this position is liquidated.
For more information about
trading futures on Bitget, refer to our complete guides:
What is funding rate?
Since the first
crypto futures product hit the 4cfa50a4-86c6-47ae-b44c-37df69c4d5d0, most traders have been opening long positions. As a result, contract prices deviate significantly from the underlying's spot price. To keep the price in line, a periodic payment calculated based on the difference between long and short positions is invented.
In essence, it is a mechanism to ensure that the futures price closely reflects the real-time market value of Bitcoin. This alignment between the futures and spot markets is crucial for the overall stability and efficiency of the derivatives market.
How funding rate works
The funding rate is typically calculated every eight hours. To understand how it works, let's break it down in the case of Bitcoin funding rate:
Positive funding rate: When the price of the Bitcoin futures contract is trading at a premium compared to the spot market price, long positions pay short positions. This incentivizes traders to hold short positions and helps bring the futures price closer to the spot price.
Negative funding rate: Conversely, when the futures contract is trading at a discount compared to the spot price, short positions pay long positions. This encourages traders to hold long positions and helps align the futures price with the spot price.
Calculating the funding rate
The funding rate is calculated based on the following formula:
Funding rate = {average premium index (P)+Clamp[interest rate (I)−average premium index (P), a, b)
Where:
Premium Index (P) = [Max(0, Impact Bid Price - Price Index ) - Max(0, Price Index - Impact Ask Price)] / Price Index
Where:
Impact Bid Price = The average fill price to execute the Impact Margin Notional on the Bid Price
Impact Ask Price = The average fill price to execute the Impact Margin Notional on the Ask Price
Price Index: The spot price of the underlying asset
Let's say you hold a long position of 1 BTC, the funding rate is 0.01%, and BTC's price is 30,000 USDT.
You will be paying short position holders since the funding rate is positive. Your funding fee (automatically deducted from your futures account) will be: 1 x 0.01% x 30000 = 3 USDT.
Closing thoughts
The funding rate is a vital mechanism that underpins the stability and efficiency of the Bitcoin futures market. It aligns the price of futures contracts with the spot market, promoting a balanced trading environment. Traders should understand how the funding rate works and consider its implications when making decisions in the highly dynamic world of
Bitcoin futures trading. As with any trading activity, a well-thought-out strategy and risk management are essential for success in the cryptocurrency derivatives market.
Register now and start your futures trading journey today at Bitget!
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