How Does the ‘Funding Rate’ Mechanism Ensure the Perpetual Contract Price Tracks the Spot Price?

The funding rate is a small, periodic payment exchanged between traders holding long and short positions in a perpetual contract. If the perpetual contract price is trading above the spot price, the funding rate is positive, meaning long position holders pay short position holders.

Conversely, if the contract trades below the spot price, the rate is negative, and shorts pay longs. This mechanism incentivizes arbitrageurs to push the contract price back toward the spot price, keeping them closely tethered.