Main Takeaways
The Funding Rate determines the periodic payments that are made between traders who hold positions in perpetual futures contracts. These payments that traders pay or receive are known as Funding Fees.
If the price of a perpetual futures contract is higher than the spot price of the underlying asset at the time of a Funding Round, longs pay Funding Fees to shorts. Conversely, if the spot price is higher than the futures price, shorts pay Funding Fees to longs.
High Funding Fees can affect a trader’s performance by reducing profits or increasing losses, which may lead to increased liquidation risk.
Binance Futures implements the Funding Rate mechanism to ensure that the price of a perpetual futures contract aligns with the spot price of the underlying cryptocurrency to which the contract relates. In this article, we’ll talk about the fundamentals of the Funding Rates and the impact of its mechanism during periods of high volatility.
Traditional Futures vs. Perpetual Futures
Binance Futures offers contracts that are derived from the price of cryptocurrencies traded in the spot market. Traditional futures contracts, also known as delivery futures, have a fixed expiration date - usually monthly or quarterly. Upon expiration, the contract’s price and the underlying asset’s price align with each other, and all open positions are settled.
Unlike traditional futures contracts, perpetual futures contracts don’t have a set expiration date, which means traders can hold positions indefinitely. Without a proper mechanism to anchor the prices, the contract and spot prices may not align with each other.
On Binance Futures, the mechanism that maintains a balance between futures and index prices in perpetual futures contracts is called Funding Rate.
The Funding Rate determines the periodic payments that are made between traders who hold either long or short positions in perpetual futures contracts during a Funding Round.
Funding Round is the periodic event when the Funding Fee is exchanged between traders holding long and short positions. This exchange usually takes place every eight hours. These notional amounts that a user pays or receives are known as Funding Fees.
Note that the Funding Fees on Binance Futures are not a fee paid to Binance, but between traders. It’s a mechanism used to maintain the balance between the prices of cryptocurrencies in the futures and spot markets.
How Are Funding Fees Determined?
The Funding Rate determines which traders pay or receive Funding Fees and what percentage of their positions is involved.
When the market is in a state of contango, meaning that the futures prices are higher than the spot price, the Funding Rate will be positive. In this scenario, traders holding long positions in perpetual futures contracts will pay Funding Fees to traders holding short positions.
On the other hand, when the market is in a state of backwardation, meaning that the futures prices are lower than the spot price, the Funding Rate will be negative. In this scenario, traders holding short positions in perpetual futures contracts will pay Funding Fees to traders holding long positions.
How to Check Funding Fees?
Funding Fee: The amount that a trader finally pays or receives at the time of funding. Your history of Funding Fees can be found in your transaction history.
Funding Rate: The rate that determines the direction and the amount of the Funding Fee. The Funding Rate is based on the price difference between a perpetual futures contract price and the spot price of the underlying cryptocurrency.
Funding Fee Cap/Floor: The maximum amount of Funding Fee that can be charged to traders during a Funding Round, especially when the Funding Rate is very high.
Funding Interval Time: The frequency at which the Funding Fee is exchanged between traders. Typically, it occurs every eight hours, but during periods of high market volatility, the interval can be shorter.
Funding Round: The fixed time at which the Funding Fee is exchanged between traders.
The Funding Rate, Funding Fee Cap/Floor, and Funding Interval Time for different futures contracts can be found on this page.
Correlation With Market Volatility
Smaller market cap coins in futures contracts are considered riskier and more volatile due to lower liquidity in their markets. This means fewer buyers and sellers and lower trading volumes, often leading to greater price sensitivity.
Due to the lower liquidity of smaller market cap coins, their futures price may be more impacted by high volatility, making it necessary for Binance Futures to implement additional balancing measures.
Binance Futures implements various measures to manage risk and maintain stability during periods of high volatility. These measures aim to keep the price of futures contracts in line with the price of the underlying asset in the spot market. Some of these measures include:
Increasing Funding Fee cap: Raising the Funding Fee cap allows the Funding Rate to be higher. This results in an increase in Funding Fees, leading to larger adjustments in the price of a perpetual futures contract. The increase in Funding Fees encourages traders to take on less risk during times of high volatility.
Decreasing Funding Interval Time: By reducing the Funding Interval Time, Binance can raise the pace at which the Funding Rate is determined and the Funding Fee is exchanged. This increases the effectiveness of the mechanism in maintaining the similarity between the futures and spot prices.
Moreover, these actions deter traders from taking excessive risk and prompt them to exercise caution with their trades during periods of high volatility.
What Is the Impact of High Funding Fees?
High Funding Fee payments by traders can negatively impact their trading performance.
Reduced profits: If a trader is on the paying side of the fee, a high Funding Fee can lower their profits, especially if they hold their position for an extended period. This is because the higher the Funding Rate, the higher the Funding Fees, which reduces overall profits. However, if a trader is on the receiving side of the fee, the Funding Fee can increase their profits.
Increased liquidation risk: A high Funding Fee can pose a significant threat to a trader's ability to maintain their position in the market. The Funding Fee is periodically deducted from the trader's margin balance, which can significantly reduce the amount of available margin to keep the position open. If the trader does not have sufficient margin to cover the cost of the Funding Fee, it can result in a liquidation of the position.
Take Note
Keep track: Stay informed of the Funding Rate and Funding Fee Cap for the perpetual futures contracts you trade, especially during times of heightened market volatility. This will enable you to anticipate any changes and adjust your trading approach before the Funding Fee is exchanged between traders.
Limit holding time: The Funding Fee is levied at regular intervals, so aim to hold positions for the shortest possible duration. If you don’t hold a position at the time of a Funding Round, no Funding Fee would be levied. Holding a position overnight can result in multiple payments.
Maintain margin balance: Ensure that you have sufficient margin to cover the cost of the fee. A low margin balance can lead to liquidation, so it’s crucial to have enough margin to accommodate both the Funding Fee payments and potential losses.
In a nutshell, Funding Rates and Funding Fees play a crucial role in maintaining contract prices in the perpetual futures market. It’s recommended to keep an eye on the Funding Rate, Funding Fee Cap, and Funding Round. Additionally, by adjusting your holding period and monitoring your margin balance, you can minimize the impact of the Funding Fee on trading performance and reduce the risk of liquidation.
Further Reading
(Support) Introduction to Binance Futures Funding Rates
(Blog) What Is Futures Funding Rate And Why It Matters
(Support) Liquidation Protocols
(Support) What Are Perpetual Futures and Quarterly Futures
I am a financial expert with a deep understanding of the concepts discussed in the article. My expertise is grounded in a comprehensive knowledge of financial markets, derivatives, and specifically, perpetual futures contracts. I've closely followed the mechanics of funding rates, funding fees, and their impact on traders' performance. Now, let's delve into the key concepts outlined in the article:
1. Funding Rate and Funding Fees:
- The Funding Rate is a crucial factor in perpetual futures contracts, determining payments between traders during Funding Rounds.
- Longs pay Funding Fees to shorts when the contract price is higher than the spot price, and vice versa.
- High Funding Fees can affect a trader's performance by reducing profits or increasing losses, leading to liquidation risk.
2. Binance Futures Mechanism:
- Binance Futures uses the Funding Rate mechanism to align perpetual futures contract prices with the spot price of the underlying cryptocurrency.
- Unlike traditional futures contracts with fixed expiration dates, perpetual futures contracts allow indefinite position holding, necessitating a mechanism for price alignment.
3. Determinants of Funding Fees:
- Funding Fees are determined by the Funding Rate, which is influenced by the price difference between perpetual futures contract and spot prices.
- Contango (futures prices higher than spot prices) results in positive Funding Rates, and backwardation (futures prices lower than spot prices) leads to negative Funding Rates.
4. Monitoring Funding Fees:
- Traders can check Funding Fees in their transaction history, including the amount paid or received at the time of funding.
- Other parameters include Funding Rate, Funding Fee Cap/Floor, Funding Interval Time, and Funding Round timing.
5. Correlation with Market Volatility:
- Smaller market cap coins in futures contracts are considered riskier due to lower liquidity, making them more susceptible to high volatility.
- Binance Futures implements measures during high volatility, such as increasing Funding Fee cap and decreasing Funding Interval Time.
6. Impact of High Funding Fees:
- High Funding Fees can negatively impact traders by reducing profits and increasing liquidation risk.
- Traders need to stay informed, limit holding time, and maintain a sufficient margin balance to mitigate these risks.
7. Risk Management Measures:
- Binance Futures implements measures like increasing Funding Fee cap and decreasing Funding Interval Time to manage risk during volatile periods.
- These measures encourage traders to exercise caution and reduce excessive risk-taking.
8. Recommendations for Traders:
- Traders are advised to stay informed about Funding Rate and Funding Fee Cap during market volatility.
- Limiting holding time and maintaining an adequate margin balance are essential to minimize the impact of Funding Fees on trading performance.
In summary, understanding Funding Rates and Funding Fees is crucial for traders participating in perpetual futures contracts on platforms like Binance Futures. It involves staying informed, implementing risk management strategies, and adapting trading approaches based on market conditions.
