Funding Rate

Note: Funding rate is a unique price return mechanism for perpetual contracts, invented by the founder of Bitmex.

What is the funding rate？

In a word:

The funding rate is a unique price return mechanism for perpetual contracts.

The funding rate is the price rebalancing mechanism of the perpetual contract. Unlike traditional contracts that need to be delivered when the contract expires (the delivery contract will be delivered at the index price, so the contract price will eventually return to the index price), the perpetual contract has no expiration or delivery, so it needs to be settled through the "funding rate mechanism" to let the contract price anchor the spot price.

Funding Fee Settlement Rules

In the perpetual contract, every 8 hours is a period, and the funding rate is settled at the end of each period (it can be regarded as rebalancing the price every 8 hours). Settlement is done 3 times a day, namely 00:00, 08:00, and 16:00. The above time is GMT+8 time.

Only users who hold positions at 00:00, 08:00, and 16:00 need to charge or pay funding fees. If the positions have been closed before settlement, no funding fees need to be charged or paid.

At the time of settlement, whether the user should charge or pay the funding fee is determined by the positive or negative of the funding rate of the current period and the long or short of the user's positions. When the funding rate is positive, the long position will pay the funding fee, and the short position will charge the funding fee; when the funding rate is negative, the long position will charge the funding fee, and the short position will pay the funding fee. Funding fees are exchanged entirely between users, and the platform does not collect any fees from them.

The purpose of this is to punish the powerful party and subsidize the weak party, to encourage the return of the contract price.

For example:

When Bitcoin continues to rise, most people are going long. At this time, the contract price is 30,000, and the spot price is only 29,500, so the price has deviated. If the funding rate is calculated to be 0.15%, the long positions will be paid 0.15% of the nominal value of the positions to the short positions every 8 hours. Because short positions are profitable, many people will buy BTC to charge a funding fee of 0.15% every 8 hours. This short-selling arbitrage behavior will cause the contract price to go back down, allowing it to return to the spot price.

The settlement of the funding fee is carried out in units of positions and is directly added or deducted from the position margin.

The funding fee is charged in the same currency as the margin. The position that is charged is the position that is judged to be a price deviation.

Funding fee = position value * current funding rate

Position value = the number of positions * size * mark price

Funding Rate Calculation

The funding rate consists of two parts: the base interest rate and the average premium index.

Base interest rate

Perpetual contracts are composed of two currencies: the underlying currency and the quote currency. For example BTCUSDT perpetual contract, the underlying currency is BTC, and the quote currency is USDT.

Underlying currency interest rate: the daily lending rate of the underlying currency in the market. If the underlying currency of the BTCUSDT contract is BTC, the interest rate of the underlying currency is the daily lending rate of BTC.

The quote currency interest rate: The daily lending rate of the currency of account in the market. If the quote currency of the BTCUSDT contract is USDT, the interest rate of the quote currency is the daily lending rate of USDT.

Base interest rate = (interest rate of currency of account – interest rate of underlying currency) / funding rate settlement frequency

Currently, the currency of account interest rate of all perpetual contracts is 0.06%, the underlying currency interest rate is 0.03%, and the funding rate settlement frequency is 3 times per day. Therefore, the base interest rate of all current perpetual contracts is 0.01%.

When there is no sentiment in the market (no positive or negative premium):

Funding rate = comprehensive interest rate = 0.01%

Average premium index

The contract price may have a premium or discount compared to the spot price. We use the premium index to measure the premium of the contract, which is finally reflected in the funding rate.

The premium index is an important parameter of the contract. The higher the premium, the higher the funding rate; the lower the premium, the lower the funding rate. By raising or lowering the funding rate, the contract price will return to a relatively reasonable level.

Basic Rate of Funding Rate

The basic rate of funding rate reflects the curve inherited from the previous period's premium level with time decay.

The basic rate of funding rate = current funding rate * (time interval from the current time to the current settlement/settlement cycle)

Example:

The current time is 8:30, the BTC perpetual contract funding rate for this period is 0.01%, the settlement time for this period is 16:00, that is, there are 7 hours and 30 minutes before settlement, and the settlement cycle is 8 hours (settlement every 8 hours once)

Then the current funding rate basis rate = 0.01% * ( 450 / 480 ) = 0.009375%

Fair Price

The fair price is a relatively reasonable reference price for the perpetual contract calculated based on the current spot index price and the current basic rate of funding rate.

Fair price = index price * (1 + basis rate of funding rate)

Example:

The current BTC index price is 10,000 USDT, and the basic rate of the BTC perpetual contract funding rate is 0.005%

Then the current fair price of BTC perpetual contract = 10000 * ( 1 + 0.005%) = 10000.5 USDT

Impact price (deeply weighted buy and sell price)

The impact price refers to the average transaction price of the “impact value” of simulated market price trading based on the current order status. It indicates the strength of buying and selling in the market. If the buyer is strong, the price slippage will be small when the impact is sold, otherwise, the price slippage will be large. By impact prices, we can assess the strength and weaknesses of buyers and sellers, which is used to calculate premiums.

E.g.

Sell order: (20000, 0.1) (20100, 0.3) (20200, 0.5) (20300, 0.5)

Impact price = 10000 USDT

Simulate the market price buying impact value of 10000 USDT:

Impact buying price = average transaction price = (20000 * 0.1 + 20100 * 0.3 + 20200 * 0.0975) / (0.1 + 0.3 +0.0975) = 20100.5

Same for impact selling price

Premium index

The premium index reflects the current premium situation caused by the combination of the basic rate of funding rate and the deviation of the depth-weighted buying/selling price relative to the fair price.

The premium index is calculated every minute.

Premium index = [ Max ( 0, impact buying price – fair price ) – Max ( 0, fair price – impact selling price ) ] / index price + basic rate of funding rate

It can be seen from the formula:

a) When impact buying price <= fair price <= impact selling price, the market order is reasonable:

premium index = basic rate of funding rate

b) When the fair price < impact buying price < impact selling price, the buying is strong:

premium index = (impact buying price – fair price) / index price + basic rate of funding rate

c) When impact buying price < impact selling price < fair price, the selling is strong:

premium index = (impact selling price – fair price) / index price + basic rate of funding rate

Average premium index

The current average premium index is the arithmetic average of all premium indexes of the current period within the last hour. Calculated every minute.

Average premium index = 1h MA (premium index)

Funding rate

The funding rate is jointly determined by the base interest rate and the average premium index and is calculated every minute. The formula is as follows:

Funding rate = clamp (average premium index + clamp (comprehensive interest rate – average premium index, premium deviates from the upper limit, premium deviates from the lower limit), funding rate upper limit, funding rate lower limit)

Where clamp is an interval limiting function. When the target value exceeds the upper and lower limits, only the boundary value will be taken.

Composite rate - the average premium index, bounded by the premium deviation upper bound and the premium deviation lower bound, in between;

The funding rate is limited by the upper limit of the funding rate and the lower limit of the funding rate, which is in between.

Example: the specific parameters of the BTCUSDT contract are as follows:

Premium deviation from upper limit: 0.05%

Premium deviation from lower limit: -0.05%

The upper limit of the funding rate: 0.375%

The lower limit of the funding rate: -0.375%