General Knowledge Crypto Metrics

How to Use Futures Perpetual Funding Rate: Crypto Trading Guide

The future perpetual funding rate chart can be used as a technical analysis tool. In conjunction with other tools, this tool can be used to predict whether the market will go up or down. For example, some users think that the market will go up if you have a high funding rate with a high open interest rate. However, that thinking is wrong, so we intend to explain what can be analyzed and what conclusions can be drawn from this metric in this article.

Brief Explanation of Perpetual Futures Contracts

Before we talk about the funding rate and why it is applied, we should speak of perpetual futures contracts. Futures contracts are agreements to sell or buy a cryptocurrency at an already fixed price on an already set future date.  This way, traders ensure their gains so they can make precise profit models. 

In contrast, perpetual futures contracts never expire; you can hold them whenever you want. But this pro comes with a con: the price between perpetual futures and spot can diverge. So exchanges set a funding rate to maintain a balance between bullish and bearish positions to reduce divergence. Also, you’ll never own the asset; hence, you only trade a representation of the purchase.

The main advantage of perpetual futures is the leverage. Investors can buy positions higher than their capital and sell assets that they don’t even have!

What is the funding rate?

The funding rate consists of periodic payments between traders. These payments are made to maintain the perpetual futures contract price reasonably close to the asset price in the spot market. 

The funding rate is calculated in different ways, depending on each exchange. However, in most Exchanges, it is estimated several times a day, and payment is made every eight hours. Because each Exchange (Binance, Kraken, crypto.com, among others) has its way of calculating the funding rate is not explained in-depth. Nonetheless, for most cases, the funding rate comprises two elements: a fixed interest rate and a premium. 

If the funding rate is positive, the market is bullish, at which time long traders should pay short traders. Conversely, when the funding rate is negative, the market is bearish, so short traders must pay long traders.

The funding rate can be viewed in real-time on the websites of each exchange that has a perpetual futures option. 

How does the funding rate payment works?

This value represents the percentage of the amount you’ll have to pay or receive. It’s like a fee but depends if you’re in favor or against the trend. Now, this percentage considers the total amount of your position, know as notional value. In other words, the funding rate is a function of your capital leveraged. 

Let’s make an example. Imagine you have $100 invested in a long position, and it’s 5x leveraged. The funding rate of the exchange is 0.1% daily charged every 8 hours (0.033% each period). If you want to maintain your position for a day, you’ll have to pay  0.5% just for the funding rate. That is 183% yearly! Remember, leverage multiplies every percentage.

Funding rate properties

  • Controls the balance. As we said earlier, the funding rate maintains the equilibrium between buyers and sellers. The more different the futures contract from the spot price, the higher the funding rate. Investors can take advantage of the funding rate claiming it by betting against the trade. Hence, futures prices will approach spot price.
  • Measuring sentiment. It can be said that the funding rate is a direct consequence of the market traders’ sentiment. For example you will not take a long position if your sentiment is bearish. This tool can also be used as a bias control. If we have a market that just had an uptrend and the price is now holding steady, but the financing rate keeps increasing, you can say that the market is saturating to the maximum. So at that point it would not be wise for you to make trades that continue with the trend, but rather it would be more prudent for you to look for counter-trend opportunities.

Final thoughts

In conclusion, the funding rate is an indicator of the sentiment of market operators, with which we can establish whether a market is saturated with buyers or sellers. Therefore, using only this tool to make decisions on operating an asset could lead to erroneous predictions. Some of the recommended indicators to complement the technical analysis are the relative strength index, Bollinger bands, and others. 

Lastly, don’t forget that the market can also be affected by external factors, such as social media.

Related posts

3d chart tokens
Traditional Futures v/s Perpetual Futures
The derivatives market has benefited from the rapid growth of the digital asset industry in...
How to Use Moving Averages: Crypto Trading Strategy Guide
Most of us, when first entering the cryptocurrency market, don’t know many technical analysis tools....
notes with coins
How to Use Bollinger Bands: Crypto Trading Guide
Bollinger bands are a technical analysis tool developed by John Bollinger in the early 1980s....