What is a Funding Rate?

Traditional futures contracts always have an exact expiration or settlement date. Although its price deviates from the underlying asset’s price (basis) during its lifetime, these will always converge at expiration.

Perpetual contracts，on the other hand, never expire and never settle in the traditional sense. As such, their prices could end up becoming significantly different than the underlying assets that they derive their value from. To prevent this from happening, a Funding Rate mechanism attempts to tether a contract’s price to its asset’s price.

To learn more about perpetual contract, read What is a perpetual contract?

What is a Funding Rate?

The funding rate is calculated by considering the interest rates for both trading pair currencies and the Premium Index. The calculation either yields a positive (longs pay shorts) or a negative (shorts pay longs) funding rate. 

On Phemex, the funding rate is calculated in real time based on the Premium Index and other applicable parameters. A positive or negative funding rate creates an economic incentive for traders to adjust their positions, which may contribute to the Last Traded Price moving closer to the relevant reference price over time.

\*\*For example\*\*, if the Last Traded Price is significantly higher than the Mark Price, this indicates that the perpetual contract is trading at a premium to the reference price. Such a premium can be associated with stronger buying demand or aggressive buy-side order flow. When the premium results in a positive funding rate, traders holding long positions generally pay traders holding short positions at the funding interval.

As such, they will likely end up paying short position holders at the time of funding. Because traders are aware of when funding will occur, they then become less likely to want to hold these positions and more likely to sell. Hence, the Last Traded price will continually drop and approximate the Mark Price.