Important informations:
Unlike traditional futures contracts, long futures contracts offer investors the ability to hold positions without an expiration date.
Because long futures contracts are never settled, exchanges use Funding Rates to ensure that futures prices and index prices consistently match.
Funding Rates are regular payments made by users with long or short positions based on the difference between long-term contract markets and spot prices.
Differences between Traditional Futures and Long Futures
An important feature of traditional futures contracts is the expiration date. Once the contract expires, a process known as settlement begins.
Traditional futures contracts are typically settled at monthly or quarterly intervals. During settlement, the contract price reaches the spot price and all open positions expire.
Long-term contracts are commonly offered by crypto derivatives exchanges and are designed similarly to traditional futures contracts. But there is a significant difference in long-term contracts.
It is possible for investors to hold positions that do not have a specific expiration date, unlike traditional futures, and they do not need to keep track of various expiration months. For example, an investor can hold a short position indefinitely as long as it is not liquidated. As a result, trading long-term contracts is very similar to trading pairs in the spot market.
Because long-term contracts are never settled in the traditional sense, exchanges need a mechanism to ensure that futures prices and index prices coincide consistently. This mechanism is called the Funding Rate.
What is the Funding Rate?
Funding Rates are regular payments made to users with long or short positions based on the difference between long-term contract markets and spot prices. Therefore, investors will either pay or receive payments depending on open positions.
Crypto Funding Rates prevent permanent differences in the prices of both markets. This rate is recalculated several times a day, and on Binance Futures the calculation is made every eight hours.
Binance Futures Funding Rates (indicated in red) and the countdown to the next funding (indicated in yellow) appear as follows:
Figure 1 - How the Funding Rate appears on Binance Futures
Source: Binance Futures
What Determines the Funding Rate?
Funding Rates consist of two main elements: Interest rate and premium.
The interest rate on Binance Futures is fixed at 0.03% per day (0.01% per funding interval), with the only exception being contracts such as BNBUSDT and BNBBUSD where interest rates are 0%. In addition, the premium varies depending on the price difference between the long-term contract and the benchmark price.
During periods of high volatility, there may be a difference between the long-term contract price and the benchmark price. In such cases, the premium increases or decreases depending on the circumstances.
A large difference between two prices means the premium is high. Conversely, a low premium indicates that the difference between the two prices is small.
When the Funding Rate is positive, the price of the long-term contract is generally higher than the benchmark price. Therefore, investors in long positions pay those in short positions. Conversely, a negative Funding Rate means that short positions pay off long positions.
Funding Rates are paid between spouses. Therefore, since Funding Rate payments are made directly between users, Binance does not receive a commission on these payments.
How Does the Funding Rate Affect Investors?
Funding Rates can have a huge impact on a person's profit and loss because funding calculations also take into account the amount of leverage used. When high leverage is used, the investor who pays for the funding rate may suffer losses or even be liquidated in markets with low volatility.
On the other hand, being on the receiving end of the payment can be very profitable, especially in markets that move within a certain range.
Therefore, investors can develop trading strategies that will turn Funding Rates to their advantage and make profits even in markets with low volatility.
Funding Rates are essentially designed to encourage investors to take positions that will keep long-term contract prices in line with spot markets.
Correlation with Market Sentiment
Historically, crypto Funding Rates tend to correlate with the overall trend of the underlying asset. This correlation does not indicate that Funding Rates determine spot markets, but rather the opposite. The chart below shows the relationship between Funding Rates and spot BTC prices over a 30-day period:
Chart 1 - Correlation between Funding Rates and change in BTC prices
Source: Glassnodes, data from December 26, 2021 - January 25, 2022.
As shown in Chart 1, with the decline in BTC prices since the end of 2021, Funding Rates have also decreased. High Funding Rates are a sign that there is confidence in the potential for the market to continue to rise. Still, many investors have noticed the increase in funding fees, allowing futures prices to align with the spot price.
Comparison of Historical Funding Rates on Crypto Derivatives Platforms
Currently, nine major exchanges offer long-term contracts. Investors generally prefer platforms that offer the lowest Funding Rate as it can have a significant impact on profits and losses. Here is a simple comparison of Bitcoin futures Funding Rates between major exchanges:
Chart 2 - Historical Funding Rates for a 30-day period on major platforms
Source: Glassnode, data from 26 December 2021 - 20 January 2022.
Generally, Funding Rates on major exchanges average -0.007%. As we mentioned before, these rates vary depending on changes in the price of the underlying asset.
According to Glassnode, Binance Futures historical Funding Rates average 0.0094%, below the industry average. For example, a user may pay $9.4 for a $100,000 position on Binance Futures, while Funding Rates may be 10-20% higher on other platforms.
How Does Binance Keep Futures Funding Rate Low?
One of the main reasons why Binance Futures has been able to keep its Funding Rate low is because arbitrage can be easily done between the spot and futures markets.
Crypto markets never sleep. Therefore, arbitrage opportunities are constantly available. Binance Futures allows users to take advantage of these opportunities by allowing them to easily and quickly switch between spot and futures markets.
Therefore, inefficiencies between long-term contracts and benchmark prices are eliminated by arbitrage, and as a result, the difference between the two prices decreases. Although extreme volatility can occasionally cause spikes in Funding Rates, arbitrageurs will quickly seize these opportunities. Thus, Funding Rates eventually return to their mean.
Funding Rates also tend to be higher on other exchanges where arbitrage is more restricted. This is because transitions between spot and futures markets are more limited. For example, some exchanges limit the number of transfers that can be made in a day.
Conclusion
Crypto Funding Rates play an important role in the long futures market. Most crypto derivatives exchanges use a Funding Rate mechanism to ensure that contract prices always remain in line with the index. These rates change depending on whether the asset price is rising or falling and are determined by market forces.
In addition, crypto Funding Rates also vary between exchanges. On some exchanges, these rates are consistently high. In contrast, others like Binance Futures manage to keep the Funding Rate low. The main reason for this is the differences between the trading platform features of the exchanges. It is easier to arbitrage on exchanges that allow easy switching between spot and futures markets. Thus, inefficiencies are quickly eliminated.
For more information, you can read the following useful articles:
(Support) Differences Between Long-Term Contract and Traditional Futures Contract
(Support) Binance Futures FAQ Library
(Blog) How Liquidation and Insurance Funds Work and Why Are They Important for Crypto Derivatives? (Part 1)
(Blog) How Liquidation and Insurance Funds Work and Why Are They Important for Crypto Derivatives? (Part 2)
(Academy) How to Trade Crypto with Common Sense?
