What are Funding Payments?
Let's find out Funding Payments meaning, definition in crypto, what are Funding Payments, and all other detailed facts.
In cryptocurrency derivatives exchanges, funding payments are used for perpetual contracts to bring the transaction price closer to the underlying asset's index price. The price of a perpetual contract is not always the same as the price of an underlying asset because a perpetual contract is a derivative.
For instance, the price of a Bitcoin (BTC) perpetual contract during a bull market is generally higher than the price of BTC in the spot market. This happens because people are more bullish and believe that the price will continue to grow.
Funding payments were adopted by derivatives exchanges to reduce the difference between the spot market and the perpetual market. How does it work? Funding payments between traders are made automatically at fixed intervals (e.g. every 6 hours).
Traders on the long side during a bull market (the more popular side) pay to the short side during a bull market (the less popular side). This way people are encouraged to open a position on the less popular side which drives the price towards the spot price.
Funding payments are calculated by multiplying the notional value of a trader’s position by a rate that shows the price difference in a given interval (e.g. 6 hours). This rate is called the funding rate. How high the funding rate is, depends on how big the price difference is in a given interval.
When the funding rate is positive (above the spot price), short position traders receive funding from long position traders. However, when the funding rate is negative (below the spot price), it’s the other way around. The funding rate reflects the cost of capital and the steepness of the futures curve, as well as the sentiment of a trader on a particular exchange. The rates might vary depending on various market conditions.