Does a Market Maker Prefer a Stable or Volatile Funding Rate for Hedging?
A market maker generally prefers a stable funding rate for hedging. A stable rate allows for predictable hedge costs and easier risk management.
A volatile funding rate introduces uncertainty and can quickly turn a profitable hedge into a costly one, adding a layer of funding risk to the overall inventory management.
Glossar
Funding Rate
Mechanism ⎊ Funding Rate represents a periodic payment exchanged between traders holding opposing positions in perpetual futures contracts, establishing an equilibrium between contract prices and the underlying spot market.
Hedge Costs
Expense ⎊ Hedge costs represent the necessary expenditure to neutralize or reduce an unwanted market exposure, forming a direct drag on the potential profit of the underlying trading strategy.
Market Maker
Genesis ⎊ The concept of a market maker within cryptocurrency derivatives, options trading, and broader financial derivatives fundamentally addresses liquidity provision and price discovery.
Stable Funding Rate
Mechanism ⎊ Stable Funding Rate represents the differential in interest rates between perpetual futures contracts and the spot market, functioning as a key arbitrage signal within cryptocurrency derivatives exchanges.
Volatile Funding Rate
Mechanism ⎊ A volatile funding rate in cryptocurrency derivatives represents the periodic payment exchanged between traders holding long and short positions in perpetual swap contracts, dynamically adjusted to maintain price alignment with underlying spot markets.
Funding Risk
Volatility ⎊ Funding risk primarily stems from the high volatility and unpredictable directional shifts in the perpetual swap funding rate, which can rapidly turn a positive carry trade into a costly expense.