What Is the Primary Function of the Funding Rate in a Perpetual Futures Contract?

The funding rate's primary function is to tether the perpetual contract price to the spot price of the underlying asset. It is a small, periodic payment exchanged between long and short traders.

If the contract trades above the spot price, longs pay shorts (positive funding rate), incentivizing short positions to push the price down. If the contract trades below the spot price, shorts pay longs (negative funding rate), incentivizing long positions.

This mechanism prevents the perpetual contract from diverging significantly from the spot market.