How Does the Funding Rate Mechanism Keep the Perpetual Contract Price Close to the Spot Price?
The funding rate is a small payment exchanged between long and short position holders at regular intervals. If the contract price is higher than the spot price, the funding rate is positive, and longs pay shorts.
Conversely, if the contract price is lower, the funding rate is negative, and shorts pay longs. This mechanism incentivizes traders to take positions that push the contract price back towards the spot price, ensuring convergence.
Glossar
Funding Rate Mechanism
Mechanism ⎊ Funding Rate Mechanisms within cryptocurrency derivatives represent periodic payments exchanged between traders holding opposing positions in perpetual contracts, designed to anchor the perpetual contract price to the underlying spot market.
Perpetual Contract Price
Price ⎊ The perpetual contract price, within cryptocurrency derivatives, represents the spot price of the underlying asset, dynamically adjusted through an auction mechanism to maintain funding rates near zero.
Contract Price
Agreement ⎊ Within cryptocurrency derivatives and options trading, the Agreement represents the legally binding articulation of the price stipulated for a future transaction, reflecting a convergence of expectations between counterparties.
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.