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Funding: Deep Dive

Funding: Deep Dive

Beginner
2022-11-24 | 5m

In an earlier article, I covered the uniqueness of the funding mechanic to the cryptomarkets and how it revolutionized contemporary trading instruments. In this article let us take a deep dive into its inner workings.

How does funding work?

Funding rates consist of two main components. The interest rate and the premium. On Bitget futures, the interest rate is set at 0.01% every 8 hours, bringing us up to a total of 0.03% a day. The premium is determined by the difference in price between the perpetual contract and its m ark price. When the market experiences times of increased volatility or enters a strong sentiment in a specific direction, the price between the perpetual contract and the mark price may diverge. In these instances, the premium increases or decreases accordingly.

A high premium means that there is a large divergence with the mark price, whereas a low premium indicates the opposite. When the funding rate is positive, the perpetual contract is higher than the mark price. This means that leveraged markets are heavily biased on the long side, causing potential liquidity issues. Therefore long positions pay short positions in an attempt to balance out the order books. When the funding rate is negative, the price of the perpetual contracts is lower than its mark price, thus the funding mechanic favors short positions, and thus long positions pay short positions. Funding rates is a peer-to-peer mechanic, and happen directly between users without an exchange being involved thus, no fees are taken from Funding Rates.

How does this affect traders?

Funding calculations take the amount of leverage used into consideration. Therefore, funding rates may have a big impact on one's profits and losses. A trader in a position with high leverage that pays for funding may suffer losses and get liquidated even in low-volatility markets. Bitget accounts for this by allowing it to charge funding at most until the user's margin rate is equal to the maintenance margin rate and a certain percentage of the remaining amount, and the excess will not be charged. On the other hand, collecting funding can be very profitable in specific market conditions such as range-bound markets. Essentially, Funding Rates are designed to encourage traders to take positions that keep perpetual contract prices in line with underlying spot prices.

Conclusion

Crypto Funding Rates serve an important role in the perpetual futures market. Most crypto-derivatives exchanges employ a Funding Rate mechanism to keep contract prices in line with the index at all times. These rates vary as asset prices turn bullish or bearish and are determined by market forces. This is mandatory to ensure a balanced and liquid market, especially for highly volatile industries such as cryptocurrencies.

Additionally, crypto Funding Rates also differ across exchanges – on some exchanges, these rates remain persistently high. In contrast, others like Bitget Futures maintain a low Funding Rate. This is mainly due to differences in trading platform features across exchanges. On exchanges that allow a smooth transition between spot and futures markets, arbitrage is easier for traders. Thus, inefficiencies are eliminated quickly.

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Disclaimer:

The information provided above is not financial advice but for educational and entertainment purposes. Please do your own due diligence or consult a financial advisor before investing in any digital assets.

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