Funding payments are periodic payments between traders. These are designed to reduce the discrepancy between the perpetual market price and the spot market price.
To reduce the price discrepancy between the perpetual market and the spot market, derivatives exchanges adopt a mechanism called “funding payments”. The way funding payments work is that there are automatic payments between traders at fixed intervals (e.g. every hour, or every 8 hours) where traders on the more popular side (the long side during a bull market) pay the less popular side (the short side during a bull market). By doing this, people are incentivized to open a position on the less popular side, hence driving the price toward the spot price.
The funding rate effectively implies a cost of capital and the steepness of the futures curve, and indicates trader sentiment on a given exchange. It is not an interest charge nor a fee that traders pay to hold the position. The rates may vary freely depending on market conditions. Some exchanges place limits to prevent traders from facing extreme rates.
Yenwen Feng is a cryptocurrency and technology professional with vast experience as a CEO and co-founder of several startups. Since 2004, Yenwen founded Decore (Stripe Atlas for Crypto Companies), Cinch Network (Decentralized Derivatives), Cubie Messenger (Mobile Messenger, 500 Startups B5, 10M downloads), Gamelet, and Willmobile (Top mobile financial service app in Taiwan, acquired by Systex). Since 2019, Yenwen’s acted as CEO and co-founder of Perpetual Protocol, a decentralized perpetual contract protocol.
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