What Happens to the Funding Rate When a Crypto Market Is in Strong Contango?
Contango is a market condition where the futures price is significantly higher than the spot price. In a strong contango for a perpetual swap, the price is trading at a premium to the index price.
This means the funding rate will be strongly positive. Long position holders will pay a high funding rate to short position holders.
This high cost to longs incentivizes selling or shorting the contract, which pushes the perpetual swap price back down toward the spot price.
Glossar
Positive Funding Rate
Mechanism ⎊ A positive funding rate within perpetual futures contracts, prevalent in cryptocurrency derivatives exchanges, signifies a prevailing long bias amongst traders.
Funding Rate
Cost ⎊ The Funding Rate is the periodic payment exchanged between long and short positions in perpetual futures contracts, designed to anchor the contract price to the underlying spot index price.
Strong Contango
Condition ⎊ Strong Contango describes a pronounced market condition in crypto derivatives where the forward price of a futures contract or the implied forward price from a perpetual swap significantly exceeds the current spot price of the underlying asset.
Perpetual Swap Price
Index ⎊ The perpetual swap price represents the market price of a perpetual futures contract, which is designed to closely mirror the price of the underlying cryptocurrency index.