What is the funding rate in crypto, and how do we calculate it? What is the difference between positive and negative funding rates, and why are funding rates an important component of crypto trading? If you want to know these answers, you’ve come to the right place. We created a user-friendly guide to discuss funding rates and their impact on crypto investments.
Here’s all you need to know.
What Is Funding Rate in Crypto?
Funding rates are periodic payments made between traders who hold long and short positions in a perpetual futures market. Crypto funding rates balance long and short positions in futures contracts by adjusting the cost, making the prices of both contracts similar to the spot market prices.
On that note, when the value of the perpetual futures contract differs from the underlying spot price, traders will open long or short positions to get funding fees. Crypto funding rates can be positive or negative. When the funding rates are positive, traders with long positions will pay a funding fee to traders with short positions, and vice versa.
To calculate funding rates, traders consider the difference between the perpetual contract’s price and the underlying asset’s current value.
Is Funding Rate a Good Indicator?
Yes, as it provides insight into market sentiment. However, trades based on funding rates alone will not always produce consistent results. Why? Because they are subject to manipulation. This is why traders should use additional tools and strategies to help them make an informed decision.
Moreover, funding rates can vary across different exchanges. For example, the funding rate on Binance is fixed for futures: 0.03% daily. On the other hand, OKX will settle the funding rate every eight hours.
Is a Negative Funding Rate Bullish?
No, a negative funding rate in crypto indicates that the market is bearish. This means that traders expect the prices of cryptocurrencies to drop, forcing them to open short positions. To maintain their positions, traders with short positions will have to pay a funding fee to traders with long positions. A negative funding rate occurs when the value of the perpetual futures contract falls below the price of the underlying asset.
Many top crypto exchanges offer crypto funding rates live charts to help traders make informed decisions. Live charts show the current market sentiment, i.e., how most traders are currently positioned.
Significance of Funding Rates in Trading
Now that you know what the funding rate in crypto is, let’s get acquainted with its role in trading.
Funding rates play a significant role in determining a trader’s profit. Traders must pay attention to current market sentiment since it affects the level of funding rates. For example, if funding rates stay high for a long period, the market will be favorable. This means that traders with long positions will lose more money. Why? Because they’ll have to pay funding fees to traders with short positions for a long time.
On the other hand, when funding rates stay low for a long time, traders with long positions will experience higher gains. Conversely, short position holders will lose money.
Understanding the funding rates will help traders decide when to open long or short positions, i.e., when to buy and when to sell.
How Bitcoin Funding Rate Affects the Market
The BTC funding rate will have a big impact on market sentiment. For example, at the beginning of 2021, there was a big jump in Bitcoin’s funding rates that corresponded to its boost in value. During this period, the funding rates remained positive for a long time, which shows that long positions were dominant. However, BTC’s price and funding rates started to drop from mid-2021 to early 2022, leading to short positions becoming more dominant.
At the time of writing, BTC’s value and funding rates are relatively stable. This indicates a market equilibrium between long and short positions. Bitcoin is the most popular cryptocurrency in the world, which is why its funding rate will be more stable than that of even top altcoins like ETH and XRP.
Using Funding Rates as an Indicator
Funding rates are used to determine market sentiment and help traders gain insight into market trends. Traders use the crypto funding rate chart to determine whether the market is bearish or bullish. Positive funding rates indicate a bullish market, while negative rates indicate a bearish market.
Funding rates can also be used to identify trader behavior. For example, high positive funding rates may discourage traders from opening a long position because they’ll have to pay high fees.
Besides charts, traders also use the crypto funding rate heatmap to spot the next crypto crash. When the boxes turn fully orange, it is a sign that traders are paying more of their entire position size in funding fees (per annum) to stay in their long positions. On the other hand, the green color indicates more affordable fees for long traders.
Conclusion
What is the funding rate in crypto? Funding rates are periodic payments made between traders with short and long positions in a perpetual futures market. Their main goal is to balance long and short positions, provide insight into market sentiment, and encourage market participation. Funding rates can be positive and negative. Positive funding rates suggest that the market is bullish, and negative funding rates suggest that the market is bearish.