As discussed in one of our previous blog articles titled, “What are Perpetual Contracts?”, perpetual contract trading is similar to that of futures contracts whereby traders can leverage up and don’t exchange the underlying assets on the spot. The main difference between the two is that a perpetual contract has no expiration date,which means that traders can hold the contract technically forever. Without a fixed delivery date, the contract price and spot price may never converge.
In order to anchor the perpetual contract trading price to the spot price, we’ve introduced the funding mechanism. Here’s a brief overview of how it works; should the trading price sit above the spot price, long position holders will pay the funding fees to short position holders. It incentivizes traders to open more short positions and brings down trading price, shifting towards the spot price. If the trading price is lower than the spot price, short position holders will pay the funding fees to long position holders, whereby the latter is placed in the driving seat to open more positions. Thus, it drives the prices up and achieves a similar objective to narrow the spread.
How does the funding mechanism work?
- On the Bybit platform, the funding fee is incurred every 8 hours. The settlement time is fixed at 00:00 (UTC), 08:00 (UTC) and 16:00 (UTC). The spread between 00:00 – 08:00 will determine the funding rate at 16:00. Likewise, the spread between 08:00 – 16:00 will determine the funding rate at 00:00 the following day; and so forth. In other words, at 08:00, you will know the exact funding fee being exchanged at 16:00. If you hold a long or short position at 16:00, it will automatically be paid or charged according to the funding rate locked in at 08:00.
- Funding fees are not collected by the exchange; however, they are exchanged between the long and short positions. If the funding rate is positive, long position holders shall pay trading fees to short position holders. Alternatively, if the funding rate is negative, short position holders will end up paying trading fees to long position holders.
How to make profits from funding fee?
According to Bybit’s funding history, the year to date (August 2) funding rate is displayed in the figure below:
As you’ll notice, BTC has finally broken the $10,500 resistance on July 27. Since then, the price continued to skyrocket and set an annual high of $12,000 on August 2. This resulted in high trading price premiums and thus high funding rates. On August 2, Bybit’s BTCUSD contract funding rate peaked to 0.1171%. If you hold short positions on perpetual contracts whilst going long in spot, you could have earned a substantial amount of funding fees without much market risk.
During the market crash in early March, the trading price of perpetual contracts was significantly discounted compared to the spot price. The funding rate had plummeted to -0.375%. If you go long in the perpetual contracts market and hedge it by short positions in the spot market during that period, you could also earn a sizable amount in funding fees.
The elements of funding rate
The funding rate is composed of two parts, which consists of the interest rate and the premium index; the latter of which reflects the spread between trading price for perpetual contract and spot price.
Let’s take a look at the recent trends of the premium index for instance. The chart above shows that the premium index of 00:00 – 8:00 on July 28 was significantly greater than zero, which means the trading price is higher than the spot price. The bullish momentum is stronger, so the funding rate at 16:00 on July 28 also reached highs of 0.0989%.
If you want to know more about funding rates, check out our guide titled, “What is funding rate and predicted rate”.
How to check funding rate?
On the Bybit platform, traders can view the funding rate and predicted rate in the “Contract Details” column.
Taking the image above as an example, at 7:45am (UTC) on July 29 2020, the funding rate was already fixed at 0.0214% (figure on the left) for 8:00am (UTC) . As such, long position holders will have to pay this amount to short position holders at 8:00am.
When you move your mouse to “Funding Rate”, it shows the predicted rate (figure on the right) for the next funding time, which would be 16:00 in this case. The predicted rate indicated is 0.0758%, though it could potentially change as the premium index continues to update every minute until 08:00.
How much funding fee do I pay or receive?
Let’s use a hypothetical scenario. Say Ann holds a 10,000 BTCUSD long position contract. Assuming that the mark price at the funding settlement time is $11,104.14, the funding rate is 0.0757%, and the value of Ann’s position is 0.9 BTC (10,000/11,104.14); the funding fee will be 0.00068 BTC (0.9 BTC x 0.0757%).
So, as a long position holder, Ann will pay a funding fee of 0.00068 BTC in 4 hours.