What is the funding rate? Funding rate guide for beginners

Certainly, many futures traders don’t understand what the funding rate is and why the funding fees are so high. In this article, I will introduce and explain the financing rate for beginners in an easy way to understand its essence.

What is the funding rate?

The financing rate is the ratio of the amount to be paid if the prices differ between the futures market and the spot market. If the price on the futures market is higher than the price on the spot market, the funding rate is positive and the party placing the long order must pay the party placing the short order. Conversely, if the coin price is lower in the futures market than it is in the spot market, the party who placed the short order will have to pay the party who placed the long order. This is to ensure that the prices of the futures and spot markets are not too far apart. Many new traders misunderstand the futures and spot markets as being the same, but they are actually different, and margin trading, while using the same leverage mechanism as futures, is actually the same market as spot trading.

Why is there the subsidy rate?

Futures trading means futures-futures trading, this is a form of trading that allows you to buy an asset with leverage at a known, predetermined price, usually futures-futures trading with a maturity of around 1 month, 6 Months or a year and you will be forced to liquidate your position, regardless of whether you make a profit or a loss.

In contrast to the regular futures market, Eternal Futures do not have a convergence point, so the price can deviate from the spot market.

However, perpetual futures trading does not allow you to close the order forever, which causes the futures trading price to fluctuate differently from the actual price. The financing rate will create a driving force for prices in the futures market to approach the price of the spot market in order to protect the interests of traders.

Although the chart is almost the same, there is some price difference between the spot and futures markets

The above image is a comparison between the price chart of Bitcoin in the spot market and the futures market at the time of writing. You can see that they are quite similar but still have some difference. The price of Bitcoin Spot is 34363.35 while the price of Bitcoin Futures is 34334.80. The fact that the price on the futures market is lower than the price on the spot market results in a funding rate of -0.01%. This means that the short has to pay 0.01% of the total amount of its open position to the long side.

How to calculate the financing rate when trading futures

The calculation of the grant fees is very easy. Every 8 hours the exchange charges a financing fee once, depending on the position you are in, you can decide whether to get money or lose money. If you close the order before the financing fee has been charged, you will not have to pay that fee (otherwise you will not receive it). The formula for calculating the funding fee is:

• Position value that you open x financing rate = financing fee.

For example, you have 10 USD, you open a trading position with leverage of 10, your position is 100 USD, if the funding rate is -0.035%, you need to pay an amount of 100 * -0.035% = – 0.035 USD. That means you will get $ 0.035 from the short side.

Note the countdown next to Funding, which shows the countdown to the next funding fee.

For the Binance exchange, the maximum funding rate is 0.5% regardless of the market spread. The underlying funding rate is 0.01% and increases or decreases if the futures and spot markets differ significantly. You have to pay the grant fee three times a day (8 hours each time).

How Funding Fees Affect Merchants

Due to the existence of financing fees, the price on the futures market will be close to the spot price, not too far apart. This prevents traders’ predictions from being skewed by market differences.
Many people don’t like the financing fee, but its existence is necessary for the futures market.
However, when the market is too excited or scared, the pressure to pay funding fees is quite high so you need to take this into account when creating your position. The existence of funding fees will also create some funding fee trading strategies that will help generate significant profits.

What does the funding rate say?

The financing rate correlates strongly with the mood of the traders. When the market is bullish, the funding rate is usually positive, and the higher the rate, the more excited the market is. The opposite is also true, if the funding rate goes negative it means that most of the traders think the market is going to fall. This is just a guide though, the crowd isn’t always right.

epilogue

Hopefully after reading this article you will understand Funding Rate in order to have a suitable trading strategy for you and stop hating funding fees. After all, this is a fee to protect the cryptocurrency market from excessive price manipulation by sharks. See you in another article.