Traditional futures vs. unlimited futures
With traditional futures contracts, settlement is usually monthly or quarterly – depending on the contract details. At the time of settlement, the contract price converges to the spot trading price and all open positions are closed.
The perpetual futures contract is a product that is supported by many crypto derivative exchanges and is similar in design to traditional futures. The futures contract, however, has one fundamental difference.
Unlike traditional futures, investors can hold their positions forever without fear of expiration and without having to track monthly delivery. For example, an investor can hold a short position forever unless it is liquidated. Thus, trading perpetual futures contracts is very similar to trading assets in the cash market.
In short, the futures contract cannot be paid. As a result, cryptocurrency exchanges have created a mechanism to ensure that futures prices do not deviate from their underlying price index. This mechanism is called Financing rate.
What is the funding rate?
Funding rates are periodic payments to investors who take a long or short position based on the difference between the price on the futures market and the spot price. Therefore, depending on the open position, the investor must either pay or be paid.
The financing rate prevents the prices of the two markets from separating forever. It is recalculated several times a day – with Binance Futures every 8 hours.
On Binance futures platform Our funding rate (red box) and the countdown timer to the next funding line (white box) are listed below:
Photo 1 – Financing rate on the Binance Futures platform tảng. displayed
Source: Binance Futures
It is important to note that with Binance Futures, the maximum funding rate is 0.5% regardless of market volatility.
Which factors influence the financing rate?
The funding rate consists of two parts: interest rate (Interest rate) and bonus (Difference).
In the case of Binance futures, the interest rate is fixed at 0.03% per day (0.01% per financing), with a few exceptions such as LINKUSDT and LTCUSDT contracts, which offer 0% interest. Meanwhile, the premium fluctuates depending on the price difference between the futures contract and the tick price.
During times of high market volatility, the price can fluctuate between the futures contract and the tick price. During these times, the premium increases or decreases accordingly.
The greater the price difference, the higher the premium. In contrast, a low premium means that the difference between the two prices is not great.
When the funding rate is positive, the price of the futures contract is higher than the tick price, so long investors pay the short position. Conversely, a negative funding rate means that the price of the futures contract is below the market price and the short has to pay for the long.
The financing rate is paid peer-to-peer among the traders. Therefore, Binance does not charge any fees from the funding rate because they take place directly between users.
How does it affect investors?
Since the leverage used is taken into account when calculating the funding rate, the funding rate has a major impact on an investor’s profit and loss. With high leverage, an investor who pays for funding can suffer heavy losses and liquidate their positions, even if the market is less volatile.
On the other hand, getting funding can be very profitable, especially when trading between support and resistance areas.
This allows investors to devise different strategies to capitalize on funding rates and generate profits even when the market fluctuates slightly.
Essentially, the funding rate is intended to encourage investors to take positions that keep the perpetual futures contract price close to the spot price.
Correlation with market sentiment
Historically, funding rates have often correlated with the overall performance of the underlying asset. The correlation does not mean that the refinancing rates dominate the spot market, but rather the opposite. The following graphic shows the correlation between the financing rate and the spot price of BTC over a period of 30 days:
Chart 1 – Correlation between funding rate and BTC price change
Source: Binance Futures, data from December 20, 2019 to January 20, 2020.
As can be seen in Chart 1, the funding rate doubled as BTC rose earlier in the year. The increase in the financing rate encourages investors to go long contracts, which keeps prices in the spot market.
Compare historical funding rates between different crypto derivative platforms
There are currently 7 major cryptocurrency exchanges that offer perpetual futures contracts. In general, investors trust platforms with low financing rates, as these have a major impact on profits and losses. Here is a comparison of funding rates between major exchanges:
Chart 2 – Compare funding rates between major trading platforms for 30 days
Source: Skew.com, data from December 21, 2019 to January 21, 2020.
Overall, the average financing rate on major exchanges is 0.015%. As already mentioned, this financing level is based on changes in the price of the underlying asset.
According to Skew, Binance Futures’ funding rate has historically been below the industry average at 0.0094%. For example, a trader would only pay $ 9.4 for a $ 100,000 position on Binance Futures, while the number could be 10-20% higher on other platforms.
How can Binance Futures keep funding rates low?
One of the main reasons Binance Futures has been able to maintain a low funding rate is the ability to easily switch between spot and futures markets.
Cryptocurrency is a market that never sleeps. Hence, there are always arbitrage trading opportunities. Binance Futures enables investors to switch easily and quickly between spot and futures markets and to take advantage of these opportunities.
Therefore, the difference between the futures price and the tick price is always used for arbitrage in order to keep the difference between the two prices small. Although large fluctuations can lead to a sudden spike in funding rates, arbitrageurs will grab the opportunity quickly. As a result, the funding rate quickly drops to a stable level.
Funding rates are often higher on other exchanges with more limited arbitrage. The reason is the restriction on switching between spot and futures markets. Some exchanges even limit the maximum number of transfers per day.
The funding rate plays an important role in the futures market. Most crypto derivatives exchanges use a funding rate mechanism to keep the contract price in line with the index price at all times. This financing rate fluctuates as the price rises or falls and depends on many market factors.
In addition, the financing rates vary from exchange to exchange – on some exchanges this number is consistently high. In contrast, platforms like Binance Futures maintain low funding rates. This is mainly due to the different transaction volumes between the exchanges. Investors can more easily arbitrage on exchanges that allow easy switching between spot and futures markets. Therefore, the difference can be quickly eliminated.
Source: Binance blog