Crypto funding rates overview
While first considered as a potential avenue for investment back in 1992, perpetual futures weren’t put into practice in any meaningful way until 2016 by BitMEX — and they have only ever been successful in the context of cryptocurrencies.
Used by investors to hedge their risks and bet against the current market trends, as well as those looking for large gains off of relatively little capital, perpetual futures have the potential to greatly change the investment landscape. While perpetual futures have a learning curve that is not typically suited for those new to the crypto world, even the most novice users have a lot to gain from these types of investments — provided they arm themselves with the right knowledge and determination.
Crypto funding rates, explained
A futures contract is essentially an agreement between two parties to buy and/or sell their assets at a later date for a specific price. Both traditional and perpetual future contracts are known as derivatives, meaning that their value is derived from or directly linked to the value of another asset.
In the crypto world, future contracts have values that directly relate to the value of their underlying tokens. These perpetual futures contracts give crypto traders the option to hold positions without an expiration date, meaning the contracts never settle. In turn, crypto exchanges use funding rates to make sure that futures prices and index prices regularly converge.
The funding rates result in periodic payments, which are made between traders who are long or short on their positions, in the amount of the difference between the perpetual contract markets and spot prices. As such, traders will either pay on the funding rates or will receive payments instead, depending on their positions.
Traditional futures vs. perpetual futures
Traditional futures are a little bit simpler to understand — and have been around for a lot longer than perpetual futures. A simplified explanation of traditional futures is that it’s a contract between two parties who agree to buy and sell a certain investing product at a specific date in the future for a set price. This was initially used to guarantee that a buyer who knew they would need a certain item at a later date could lock in the price of the item at that time and pay for it later.
If the market price of the item goes up by the time the contract expires, the buyer made a profit since the price was locked in when the contract was made — and they can turn around and sell it at market price. If the price of the item goes down before the contract expiration date, then the buyer loses money, as they would otherwise be able to buy the items at the lower market price. The opposite happens for the seller, who profits when the market price drops — and vice versa.
Being a buyer is called the long position, and being a seller is called the short position. These terms are used for other similar concepts in the finance world, but apply to futures as well. Other terms for long and short are “bullish” and “bearish,” respectively.
In layman's terms, a bull market is when exchange-traded assets and security prices trend upward, and a bear market is when prices substantially decrease for a prolonged period.
In contrast, perpetual future contracts don’t have a set expiration date to buy or sell the asset related to the contract. It may be difficult to understand this concept at first, especially when comparing them to traditional futures but it helps to understand their purpose before their mechanisms.
Perpetual contracts are useful for a few different reasons, but they are largely used for minimizing risks, called hedging. They can also be used to create opportunities for users to be in control of a lot more of an asset than they would typically be able to invest in.
For example, when a user invests in a perpetual contract, they’re able to leverage their current capital — up to a certain number of times its value. In layman’s terms, if a user invests $100 in the perpetual contract at a 10x leverage, they are able to make gains from $1,000 worth of asset as the value of that token rises and falls.
The same is true the other way around, however. And, because the leverage is so high, the potential for loss is multiplied by 10x as well. If at any time the value of their losses is ever equivalent or above their total investment, they immediately lose that investment in a process called liquidation — even if they would’ve made gains immediately after. That’s the risk of perpetual contracts.
How cryptocurrency funding rates work
One more complicated aspect of future contracts is the fact that the value of the contracts themselves can differ from the spot price, or the value of the underlying token.
This isn’t much of an issue with traditional futures. As the expiration date of the contract gets closer, the value of the contract pushes toward the spot price. This happens because there is less potential for change in the value of the asset as it moves closer to the closing date, and in turn, the implicit bet becomes less meaningful.
Perpetual futures, on the other hand, don’t have this closing date. This means that the value of the contract can, and often does, differ from the index price of the asset. To help regulate the price of the contract and keep it in congruence with the price of the token, funding rates are used as incentive for those who decide to hold the less popular position.
If the general consensus is that the value of the token will rise, which is called holding the long position or being “bullish,” then the value of the contract will be too high compared to the index price of that token. To bring the value of the contract down, the funding rate is offered to those who bet the value of the token is going to fall. This is called holding the short position, or being “bearish.”
How funding rates are paid
Funding rates are calculated similarly depending on the exchange that offers the perpetual contract. And, the funding rate is directly proportional to how much the contract value differs from the value of the asset.
If the funding rate is positive, it means there are too many bullish investors and the funding rate gets paid to traders who are short. If the funding rate is negative, the traders who are short are the ones who pay.
This funding rate gets calculated multiple times a day, but it again differs by the exchange. In general, though, it’s calculated once every 4 to 8 hours. To profit (or lose) from these funding rates, users have to actively be holding positions in the contract. If the contract is closed before the calculation and payout, nothing happens.
What is arbitrage in crypto trading?
There is a strategy in crypto, known as crypto arbitrage trading, in which investors capitalize on the sometimes slight price discrepancies of tokens or coins on the different markets or exchanges. For example, it’s common for one exchange to have a coin price that’s slightly higher or lower than another, and traders are banking on this happening.
To capitalize on these price discrepancies, traders will buy a coin or token on one exchange and then sell it simultaneously (or as close to it as possible) on an exchange where the price is higher. That way they’re raking in a guaranteed profit on the purchase and sale of the token with little or no risk. The only requirement is finding a price discrepancy across multiple exchanges that will allow for this type of arbitrage trading to take place.
But the easy profit isn’t the only draw of arbitrage trading. The other benefit is that traders don’t have to be professional investors, nor do they need to have access to expensive trading software or setups to pull it off.
By using arbitrage trading, traders can take advantage of the funding rate by positioning themselves as neutral by taking an opposite position on two different platforms. In other words, the trader can be bullish on one exchange but bearish on another, betting that the value of a token will drop on one exchange but then betting that it will increase on another.
This allows them to earn funding rates without closing any of their positions. It also allows traders to hedge against price volatility.
Pros and cons of crypto future trading
- High profit opportunities, even in stable markets
- Versatile hedging possibilities
- No expiration date on contracts
- Complicated, advanced crypto trading, not suited for beginners
- Highly volatile and unpredictable
- Risk of big losses
Pros of crypto future trading
High profit opportunities, even in stable markets
Because of the ability to leverage at a very high multiplier, there’s the potential for users to gain an incredible amount of returns on their crypto positions with little investment. If a user invests at a 100X multiplier, even a 1% change in the value of the asset can create a huge return on investment.
Versatile hedging possibilities
Funding rates create opportunities for larger investors to minimize losses by betting against the market. Users with locked tokens are also able to guarantee the value of their tokens for when they become available to the market.
Plus, the ability to capitalize on arbitrage trading opportunities allows traders to earn funding rates without closing their positions — and they hedge against price volatility in the process.
No expiration date on contracts
Traditional traders who utilize traditional future contracts are limited by the expiration date of these contracts. On the other hand, perpetual contracts allow for these users to invest for as long as it’s beneficial to them.
Cons of crypto future trading
Complicated, advanced crypto trading, not suited for beginners
The concept of perpetual contracts is not an easy one for users of any level to understand – and this learning curve is typically steeper for someone new to the investment landscape. Attempting to work with perpetual contracts and potentially misunderstanding a core concept can lead to extremely unfortunate consequences for the user.
Highly volatile and unpredictable
Because of their nature as derivatives, contracts have values that are just as stable as the value of the asset they’re built from. Anyone who’s worked within the crypto-sphere is intimately familiar with just how incredibly volatile the markets can be. This type of volatility can create situations with trends that are impossible to predict accurately or precisely.
Risk of significant losses
The same way that there’s the potential for huge gains using leverage, perpetual contracts also come with the very real possibility of losing your investment — and it can happen very quickly. If at any point the value of the loss with leverage exceeds a user’s initial investment, they’re immediately subject to liquidation of that entire investment. And, that’s true even if they would have gained value at the next funding rate calculation.
For example, if a user invests at 50X leverage, the moment the token’s value changes 2% in the wrong direction, the investment is liquidated and the investor loses everything they put in.
Cryptocurrency future platforms
The perpetual funding rate on this platform is either credited or debited once per hour at the start of each hour. The funding payments are made in USDC and are included in the Realized PNL for the position. Note, though, that while the funding rate is updated every hour, the rate itself is represented as an 8-hour rate, which indicates the amount of funding accounts can expect to either pay or receive over an 8-hour period.
Pros of dYdX
- Open trading platform for crypto assets
- Users can margin trade with up to 5X leverage
- Users can borrow and lend on the platform
- No gas fees when trading perpetuals or asset swapping
Cons of dYdX
- Limited assets on the swaps
- Margin trading pairs are limited
- Ethereum interest rates can be as low as 0%
Read our full review of dYdX to learn more.
ByBit primarily focuses on USDT and USDC as collateral for trading pairs like BTC, ETH, OPT, SOL, and more, but other derivatives are available for advanced perpetuals trading. Funding rates payouts happen every 8 hours, similar to many other exchanges, and are exchanged at 08:00 UTC, 16:00 UTC, and 00:00 UTC. Between those intervals, ByBit calculates the interest rate and premium index every minute.
Pros of ByBit
- Users can copy the trading actions of top earners
- Tons of USDT trading pairs
- ByBit's Leverage Token product advertises no liquidation or margin risks
Cons of ByBit
- Comparatively limited USDC trading pairs
- No trading fee tiers or discounts based on trading volume
Read our full review of ByBit to learn more.
Binance funding payments occur every 8 hours, with funding at 00:00 UTC; 08:00 UTC and 16:00 UTC for all Binance Futures perpetual contracts. Binance does not charge any fees for funding rate transfers. Traders are only liable for funding payments if they have open positions at the pre-specified funding times. If traders do not have a position, they are not liable for funding, and those who close their positions prior to the funding time will not pay or receive any funding. There is also a 15-second deviation in the actual funding fee transaction time.
Pros of Binance
- Generally low trading fees
- Over 50 tokens available on the U.S. site; over 200 on the regular Binance site
- Margin trading available; Binance Margin allows users to borrow funds for margin trading
- Up to 125X leverage
Cons of Binance
- Not available in every state
- U.S. site is limited comparatively, especially when it comes to crypto-to-crypto currency pairs
Read our full review of Binance to learn more.
With FTX, the perpetual futures have funding payments that are made every hour. Every hour, FTX measures the 1-hour TWAP of the perpetual future and the 1 hour TWAP of the underlying index to determine whether traders owe or will be getting a funding rate payment.
FTX uses the following formula to determine the funding rate to be paid or received:
Position size * TWAP of ((future mark price - index) / index) / 24
Pros of FTX
- Generally low withdrawal fees on the platform
- Numerous advanced trading options, such as margin trading
- Offers access to futures, stocks, forex, and other advanced markets
Cons of FTX
- Support options are limited
- Crypto options are limited to many of the competitors
- U.S. residents are limited to a U.S.-based platform and can’t trade on the FTX global platform
BitMEX utilizes an 8-hour funding rate. The funding rate is paid out or owed by traders daily at 4:00 UTC, 12:00 UTC, and 20:00 UTC. With BitMEX, the funding rate that is calculated during an 8-hour time frame is then applied to the following interval.
Pros of BitMEX
- A derivatives trading platform
- Traders can leverage up to 100x on Bitcoin and Ethereum
- Deep liquidity related to Bitcoin perpetuals
- Generally low trading fees
Cons of BitMEX
- Only allows crypto-to-crypto trading on the platform
- Not available to U.S. traders or traders in Cuba, Iran, Syria, North Korea, Crimea and Sevastopol, Donetsk People’s Republic, or Luhansk People’s Republic of Ukraine
Final thoughts on crypto funding rates
Funding rates are a necessary component of perpetual contracts — and in many cases, they can pay off big time for traders who make the right calls. While they are used to hedge against investments, they’re a versatile potential tool that can create opportunities for consistent and high yield on investments. Betting against the grain in future contracts can grant a solid return through these funding rates, on top of the potential for gain through holding that position in the first place.
Frequently asked questions
What does negative funding rate mean in crypto?
How are crypto funding rates calculated?
Who pays funding rates?