How Does the Funding Rate Differ from a Traditional Interest Rate on Borrowed Capital?
A traditional interest rate is a fee paid to a lender for the use of borrowed capital, usually fixed or tied to a benchmark rate, and is a one-way payment. The funding rate, however, is a two-way, dynamic payment exchanged between long and short traders, not the exchange or a lender.
Its purpose is not to finance a loan, but to incentivize market participants to keep the perpetual contract price aligned with the spot price.
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.
Interest Rate
Yield ⎊ Interest rate, within cryptocurrency derivatives, represents the cost of capital or the return on an underlying asset utilized in constructing a derivative position, impacting pricing models and arbitrage opportunities.
Effective Interest Rate
Definition ⎊ The effective interest rate represents the actual annualized rate of return or cost of borrowing, accounting for compounding frequency and all associated fees.