The funding rate is an important indicator in cryptocurrency and other derivatives markets, reflecting market sentiment and the divergence between long and short positions. By adjusting the cost of holding long and short positions, it helps investors understand current market liquidity trends and risk preferences. Accurately understanding and applying the funding rate not only aids in capturing shifts in market sentiment but also supports the development of trading strategies, allowing investors to anticipate market movements in advance. This article will provide an in-depth analysis of the definition, calculation method, influencing factors of the funding rate, and how it can help investors better assess market trends to achieve more precise investment decisions.
The calculation methods discussed in this article will use Binance Exchange as an example.
What is the funding rate?
The funding rate is a mechanism used by perpetual contract exchanges to balance leverage between long and short positions, with settlements occurring periodically (usually every 8 hours). If the funding rate is positive, long positions must pay the funding rate to short positions; conversely, if the rate is negative, short positions pay the rate to long positions. The funding rate helps prevent the price of perpetual contracts from deviating too much from the spot price. If the perpetual contract price remains significantly different from the spot price for an extended period, the funding rate mechanism encourages a price convergence. Additionally, by imposing funding rate payments, it helps to curb excessive leverage and reduce market risk.
How to calculate the Funding Fee?
The funding fee is typically calculated using the following formula:
Funding Fee = Notional Position Value × Funding Rate at Settlement
- Notional Position Value (for USDT-margined contracts) = Mark Price × Contract Size
- Notional Position Value (for Coin-margined contracts) = Contract Multiplier × Contract Size / Mark Price
Here, the contract multiplier refers to the amount of the underlying asset represented by each contract.
On Binance, the funding fee for all perpetual contracts is generally calculated every 8 hours. The settlement times are 00:00, 08:00, and 16:00 UTC+8. Market participants will only pay or receive the funding fee if they hold a position in either direction at the exact moment of the funding fee settlement. If no perpetual contract positions are held at the time of settlement, no funding fee will be paid or received.
What factors determine the funding rate?
On Binance, the funding rate is determined by the interest rate and the premium index. Binance uses a fixed interest rate when calculating the funding rate, assuming that holding an equivalent amount of cash earns more interest than holding the same value in BTC. Binance's default contract interest rate is 0.03% per day, or 0.01% every 8 hours. For some specific contracts, such as the ETHBTC contract, the default interest rate is set to 0.Another important factor in calculating the funding rate is the Premium Index (P). In some extreme market conditions, there can be a significant price difference between the perpetual contract price and the mark price. In such cases, the premium index is applied to force the prices of the two markets to converge.
The formula for calculating the Premium Index (P) is as follows:
Premium Index (P) = [Max(0, Impact Bid Price - Price Index ) - Max(0, Price Index - Impact Ask Price)] / Price Index
Premium Index (P) = [Max(0, Impact Bid Price - Price Index ) - Max(0, Price Index - Impact Ask Price)] / Price Index
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 is the weighted average value of the underlying asset listed on major spot exchanges.
The Impact Margin Notional (IMN) is used to locate the average Impact Bid or Ask price in the order book. IMN for USD-Margined contracts is the notional available to trade with 200 USDT worth of margin (price quote in USDT). IMN for COIN-Margined contracts is the notional available to trade with 200 USD worth of margin (price quote in USD).
Impact Margin Notional (IMN) = 200 USDT / Initial margin rate at the maximum leverage level
Funding Rate (F) = Average Premium Index (P) + clamp (interest rate - Premium Index (P), 0.05%, -0.05%)
The function clamp (x, min, max) means that if (x < min), then x = min; if (x > max), then x = max; if max ≥ x ≥ min, then return x.
How can I apply funding rates to judge the market in real trading?
The funding rate is an excellent indicator for gauging market sentiment in actual trading. Extreme changes in the funding rate often reflect an overextension of market sentiment. Extremely high positive funding rates indicate that the market is overly optimistic, while extremely negative funding rates suggest the market may be in a state of panic. In such situations, a price reversal could occur, making extreme funding rates a potential signal for contrarian trading. When the funding rate reaches these extremes, it may provide an opportunity for traders to consider positioning against the prevailing trend.
The chart illustrates that when BTC reached its highs, the funding rate was extremely high and positive, indicating that the market was over-optimistic, and a prolonged shock correction in BTC ensued.
In the chart, the increase in Open Interest (OI), along with the rising price and the funding rate shifting from negative to positive, indicates that the price of perpetual contracts is gradually converging with the spot price and may potentially exceed it. This suggests that many market participants are opening long positions in the perpetual contract market.
This is a classic example of a long liquidation. In the chart, the decrease in Open Interest (OI), along with the falling price and the funding rate shifting from positive to negative, indicates that the price of perpetual contracts is gradually diverging from the spot price and falling below it. This suggests that many market participants are liquidating their long positions in the perpetual contract market.
In the chart, the increase in Open Interest (OI), along with the declining price and the falling funding rate, indicates that many market participants are opening short positions in the perpetual contract market.
In summary, the funding rate serves as an important reference indicator in the cryptocurrency market, providing investors with valuable insights into market sentiment and the dynamics between long and short positions. This article introduced the definition and calculation of the funding rate, illustrating how monitoring its changes—along with other technical indicators—enables investors to better identify potential market turning points and optimize their trading strategies accordingly. However, the funding rate is not a foolproof market prediction tool; it needs to be used in conjunction with other data, such as trading volume and price trends, to avoid misinterpretation of singular signals. By systematically analyzing the funding rate and the underlying market sentiment, investors can respond more confidently to market fluctuations, enhance profit opportunities, mitigate risks, and achieve robust investment objectives.
