How Does the Funding Rate Mechanism Keep the Perpetual Futures Price Close to the Spot Price?

The funding rate is a periodic payment exchanged between long and short position holders. If the perpetual contract price is higher than the spot price, the rate is positive, and longs pay shorts.

If the contract price is lower, the rate is negative, and shorts pay longs. This payment incentivizes traders to take positions that push the contract price back toward the spot price.

The rate acts as a tether, minimizing the basis risk.