How Does the ‘Funding Rate’ Mechanism Work in a Perpetual Swap?

The funding rate is a small, periodic payment exchanged between the long and short sides of a perpetual swap contract to keep its price close to the underlying spot price. If the perpetual swap trades at a premium (above spot), the funding rate is positive, and longs pay shorts.

If it trades at a discount (below spot), the funding rate is negative, and shorts pay longs. This payment incentivizes arbitrageurs to push the contract price back toward the spot price.