How Does the “Funding Rate” Mechanism Work to Keep the Perpetual Swap Price near the Spot Price?

The funding rate mechanism is a periodic payment between the long and short positions in a perpetual swap contract, designed to keep the contract's price anchored to the underlying spot price. If the perpetual swap price is trading above the spot price, the funding rate is positive, and long position holders pay short position holders.

If the swap price is below the spot price, the rate is negative, and shorts pay longs. This incentive mechanism encourages arbitrageurs to trade against the deviation, forcing the swap price back toward the spot price.