A futures contract without an end date
A traditional futures contract has an expiry. As that date nears, its price is pulled toward the spot price, because at expiry the contract is settled against spot. A perpetual future, or perp, has no expiry. A trader can keep a position open indefinitely as long as the margin holds up.
That design is convenient, but it creates a problem: with no expiry, nothing forces the contract price to stay close to the spot price. The funding rate is the mechanism that fills this gap.
The basic idea of funding
Funding is a periodic payment exchanged directly between traders holding long and short positions. The exchange does not keep it. It is calculated from the difference between the perp price and a reference spot price, often called the index price.
- When the perp trades above spot, there is more demand to be long. Funding is typically positive, and longs pay shorts.
- When the perp trades below spot, funding is typically negative, and shorts pay longs.
The payment makes the crowded side pay a cost to stay in the position. In theory, that encourages the other side and pushes the perp price back toward spot. It is an incentive, not a hard rule, so the gap can persist.
How often and how much
Many venues settle funding every eight hours, which means three times a day, though some use shorter intervals, and the exact formula differs by exchange. The rate is applied to the notional value of the position, not the margin.
A simple illustration with made-up numbers: a trader holds a $10,000 long position, and the funding rate for the interval is +0.01%.
- Payment per interval: 0.01% × $10,000 = $1.
- With three intervals a day: $3 per day.
- Over a year, this is 0.01% × 3 × 365 = 10.95%, roughly 11% of the notional, if the rate stayed the same.
A short position in the same market would receive that $1 instead of paying it. Because funding is charged on the full position, a leveraged trader’s cost relative to their own margin is larger. With 10x leverage, the same $1 per interval on a $1,000 margin works out to the same roughly 11% of the notional, but about 110% of the margin per year, if the rate persisted. Funding rates often move around, so this is a rough yardstick only.
Mark price, index price and last price
Three prices are used in these markets, and they are easy to confuse.
- Last price. The price of the most recent trade on the perp itself.
- Index price. A composite of spot prices from several exchanges, similar in spirit to how a price index is built from several venues.
- Mark price. A smoothed fair-value estimate used to calculate profit, loss and liquidations. It is designed so that a single odd trade on one book does not liquidate people unfairly.
Funding compares the perp with the index. Liquidations typically use the mark price.
Why anchoring works, and when it does not
The funding mechanism works partly through arbitrage. If funding is strongly positive, a trader can buy spot and short the perp, collecting the funding payments while staying roughly price-neutral. This is a type of basis trade. As more traders do it, they sell the perp and buy spot, which pushes the two prices closer together.
It does not always hold. In violent moves, the perp can trade far from spot for a time, and the arbitrage can be limited by margin, withdrawal delays, exchange risk and costs. Funding also adjusts only at intervals, so fast dislocations can happen between payments. Those gaps contribute to forced closures and to the kind of chain reaction seen in a liquidation cascade.
What funding data suggests
Funding is often used as a gauge of positioning.
- Persistently high positive funding can indicate many traders want leveraged long exposure and are willing to pay for it.
- Negative funding can indicate demand for short exposure, or hedging.
- Extremes are sometimes read as a sign of crowding, which can raise the risk of sharp reversals.
These are loose readings. Funding shows the price relationship between perp and spot, not the number of traders or the size of each side, which is what the long short ratio and open interest try to describe. High funding has coincided with continued rallies at times, and low funding with continued declines. It is not a reliable predictor, and it should not be used as a trade trigger.
Costs and risks of holding a perp
- Funding is a running cost or income. Over weeks it can add up, especially at high leverage.
- Liquidation risk. Margin shortfalls close the position automatically, as in any leveraged trade.
- Exchange risk. Perps trade mostly on offshore venues, which differ in rules, insurance funds and reliability. Counterparty risk applies.
- Rule differences. Intervals, caps on the rate, and formulas differ by platform. Check the exact specification before using a product.
Cryptocurrency prices are volatile, past funding patterns do not predict future ones, and people can lose all they invest. This article is educational and is not financial, tax or legal advice.