What Is Funding and How Does It Work in the Cryptocurrency Futures Market?
Date: 2023-09-20 Author: Dima Zakharov Categories: CRYPTO PAYMENTS, BUSINESS
Funding on Cryptocurrency Exchanges: How It Works and How to Use It
Cryptocurrencies and cryptocurrency derivatives like futures are becoming increasingly popular among investors and traders. Among these, there's a concept called "funding" or "funding rate." Let's explore what it is and how it impacts the cryptocurrency market.
What Is Funding?
Funding represents periodic payments made to traders in the perpetual futures market. These payments are calculated multiple times a day and aim to prevent long-term price disparities between the underlying asset and the derivative instrument.
To understand how funding works, let's compare it with traditional futures contracts. Traditional futures contracts have a fixed expiration date after which the contract can be settled or rolled over. Perpetual futures, on the other hand, don't have an expiration date and can be held indefinitely. This can lead to significant price deviations between the perpetual futures price and the price of the underlying asset.
To mitigate these price disparities, cryptocurrency exchanges implement a funding mechanism. This mechanism helps smooth out price fluctuations in perpetual contracts and brings them closer to the price of the underlying asset.
How Is Funding Calculated?
On most centralized cryptocurrency exchanges, funding is calculated periodically, usually every 8 hours. During this time, the platform automatically deducts funds from some traders and distributes them to others based on the direction and size of their open positions. The funding rate can be either positive or negative.
If the price of the perpetual futures contract is higher than the price of the underlying asset, the funding rate is positive. In this case, long (buy) position holders pay funding, while short (sell) position holders receive funding. The opposite scenario occurs when the perpetual futures price is lower than the price of the underlying asset, resulting in a negative funding rate.
How to Use Funding in Trading?
Funding can be an important consideration for traders and investors in the cryptocurrency futures market. The frequency of funding payments can affect the profitability of trades. For instance, if the funding rate is positive and you plan to open a long position, it might be advantageous to do so just before the funding period to avoid paying funding for a short holding period. Conversely, in the case of a negative funding rate, long positions might be favorable at the beginning of the funding period to receive funding rewards.
It's essential to note that each exchange may use its formula to calculate the funding rate, so it's crucial to familiarize yourself with the specific terms and conditions of the platform you're using.
