How Does the Funding Rate of a Perpetual Swap Relate to Inventory Risk for a Market Maker?
The funding rate is a periodic payment between long and short traders of a perpetual swap contract, designed to keep the swap price close to the spot price. If a market maker uses a perpetual swap to hedge their inventory, a highly positive or negative funding rate introduces a significant, ongoing cost or income stream.
This funding cost/income must be managed as part of the overall inventory risk and can make the hedge expensive.
Glossar
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.
Inventory Risk
Exposure ⎊ The core of inventory risk within cryptocurrency derivatives, options trading, and financial derivatives stems from the potential for losses arising from unhedged positions or imbalances between assets and liabilities.
Perpetual Swap
Mechanism ⎊ Perpetual swaps, within cryptocurrency markets, represent agreements to exchange cash flows based on the difference between a cryptocurrency’s current price and a user-defined price, perpetually, without an expiration date.
Market Maker
Genesis ⎊ The concept of a market maker within cryptocurrency derivatives, options trading, and broader financial derivatives fundamentally addresses liquidity provision and price discovery.