Funding rates are periodic payments to long or short traders based on the difference between the perpetual contract markets and spot prices. The purpose of funding rates is to keep the transaction price of perpetual contracts in line with the underlying reference price. The buyers and sellers of the contract exchange interest payment regularly, allowing the contract to mimic spot trading markets. Funding rate is calculated every hour on Sat.is.
Traders will only pay or receive funding if they hold a position at one of these times. If traders close their positions prior to the funding periodic payment then they will not pay or receive funding.
How are funding rates determined?
There are two main components in Funding Rate, namely (1) the Interest Rate and (2) the Premium / Discount.
(1) Interest Rate
The contracts traded on Sat.is consist of a base currency and a quote currency. Take BTCUSDC as an example, the base currency for BTCUSDC is BTC, while the quote currency is USDC. The Interest Rate is a function of interest rates between these 2 currencies:
Interest Rate (I) = (Interest Quote Index — Interest Base Index) / Funding Interval
where
Interest Base Index = The Interest Rate for borrowing the Base currency
Interest Quote Index = The Interest Rate for borrowing the Quote currency
Funding Interval = 24 (Since funding occurs every hour)
(2) Premium/ Discount
Under certain situations, the perpetual contract may be traded at a price that is different from the Marked Price (either at a premium or a discount). In those cases, a Premium Index will be used as a means to increase or reduce the next Funding Rate, so as to maintain the consistency in trading price of the contract.
The Premium Index of each contract can be found on the specific instrument’s contract specifications page. The detailed calculation is as follows:
Premium Index (P) = (Max(0, Impact Bid Price — Mark Price) — Max(0, Mark Price — Impact Ask Price)) / Mark Price + Mark Price
At Sat.is, funding is completely free of charge, since the trading is directly peer-to-peer.
How does it impact traders?
As the amount of leverage used is considered during funding calculations, funding rates may have a big impact on a trader’s profits and losses. With high leverage, a trader that pays for funding may suffer losses and get liquidated even in low volatility markets.
On the other hand, collecting funding can be very profitable, especially in range-bound markets.
Thus, traders can develop trading strategies to take advantage of funding rates and profit even in low-volatility markets.
Essentially, funding rates are designed to encourage traders to take positions that keep perpetual contract prices line in with spot markets.
Conclusion
Funding rates play an important role in the perpetual contracts market. Crypto derivatives exchanges employ a funding rate mechanism to keep contract prices in line with spot prices at all times. These rates vary as asset prices turn bullish or bearish and are determined by market forces.
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