i am seeing too many random explanations and interpretations of funding rates and thats not good for my mental health explaining funding rate, a thread

1. at its core, funding rate is used by exchanges to force the prices of spot and perpetual contracts to converge. perps don't have any expiry time (unlike traditional futures) and hence people can hold it forever until they close or get liq'd while futures have an expiry epoch

2. to understand funding properly, we need to understand futures first traditional futures have an expiry and usually when the contract nears its maturity date; people start arbitraging, and hence in turn the prices start converging and it expires close to the spot price

3. in contrast, perp trading is more so treated as spot trading (no expiry remember) and hence funding rate plays an essential role in making the perp prices be in sync with the index price of the asset

4. the funding isn't a magical number, it has a very simple method of calculation for almost all exchanges the funding rate is simply: Funding Rate = *[Interest Rate - Premium Index] + Premium Index *a clamp function is applied with ceil/floor as 0.05% and -0.05%

5. to further break down the formula, let's first look at whats the interest rate contracts are traded with a base and a quote currency (e.g. BTC - base, USD - quote) and the interest rate is a simple calculation between them which goes like this:

6. interest quote index = the borrowing rate for the quote currency interest base index = the borrowing rate for the base currency funding interval = the periodic intervals in which rates are recalculated lets now try to make these even simpler by using an example

7. binance and bybit have the usd rate at 0.06% and btc rate at 0.03% and hence the difference being roughly 0.03% the funding interval being 8 hours for most exchanges becomes = 24/8 (once every 8 hours) hence, Interest Rate = (0.06-0.03)/(24/8) = 0.01% (the magical number

8. but then how do we enforce the convergence when spot and perpetual prices diverge greatly? we use the cute premium index Premium Index = [max(0, Impact Bid Price - Price Index ) - max(0, Price Index - Impact Ask Price)] / Price Index lets simplify this too now

9. max being simple maximum math f(x) Impact Bid Price = The average fill price to execute the Impact Margin Notional on the bid price Impact Ask Price = The average fill price to execute the Impact Margin Notional on the ask price price index = the index price of the asset

10. The Impact Margin Notional for perp contracts is the notional available to trade with 200 USDT (binance) of initial margin (quote in USDT) and is used to determine the average impact bid or ask and how deep in the order-book it is IMN = 200 / Initial margin rate at max lev

11. an example from binance: maximum degening for btcusdt is 125x and the Initial Margin Rate is 0.8%, then the IMN is 25,000 USDT (200 USDT / 0.8%), and the system will take an IMN of 25,000 USDT every minute in the order book to measure the average Impact Bid/Ask price

12. and hence premium index varies and correspondingly impacts the funding rate notice how the premium index varies greatly on days of high volatility/big moves

13. oh no the funding is too high again the degen disgusting "leverage traders" are at it again, it's because of them we will have corrections if any. the funding is reaching 0.15 omg time to stay in stables

15. funding rate is a good system for exchanges and a good metric and usable in a lot of ways in your system but please it's not as binary as negative= short squeeze because traders dumb; positive = go up because whales buying and there r some more complexities that i left out

##### Follow us on Twitter

to be informed of the latest developments and updates!

Follow @tivitikothreadYou can easily use to @tivitikothread bot for create more readable thread!