Think of a seesaw at a playground. If too many people sit on one side, it tilts too far, becoming unbalanced. To restore balance, weight must be shifted to the other side.
In perpetual futures markets, when too many traders are long (betting on price increases) or short (betting on price decreases), the market also becomes unbalanced. Funding rates act as the counterweight, incentivizing traders to take the opposite position and keeping the market price aligned with the spot price.
Unlike traditional futures, perpetual contracts don’t have an expiration date. This means there needs to be a way to keep the contract price in line with the underlying spot market price—and that’s where funding rates come in.
How Funding Rates Work
Funding rates are periodic payments exchanged between traders who hold long and short positions in a perpetual futures market.
If the perpetual contract price is trading above the spot price, long traders pay funding to short traders.
If the perpetual contract price is trading below the spot price, short traders pay funding to long traders.
This mechanism incentivizes traders to rebalance the market, preventing the perpetual price from drifting too far from the spot price.
Why Funding Rates Matter
Keeps perpetual contracts aligned with spot prices, reducing arbitrage opportunities.
Incentivizes traders to counter market imbalances by discouraging overcrowding on one side.
Helps traders gauge market sentiment—if funding is consistently positive, the market is likely bullish; if negative, bearish sentiment dominates.
💡 Example:
BTC spot price = $50,000
BTC perp price = $50,500
Funding Rate = +0.02%
Longs must pay shorts 0.02% of their position value every 8 hours.
📌 Key Takeaway: If you’re paying a high funding rate, it might be time to close your position or hedge.
📊 Strategies for Using Funding Rates
✅ Avoid Holding During High Funding: If rates are expensive, close the position before the next funding window.
✅ Use Funding as a Sentiment Indicator: High positive funding means bullish sentiment—often a reversal signal.
✅ Arbitrage Strategies: Shorting perps while holding spot assets to collect funding payments.