How To Use Crypto Funding Rates For Investing

What Are Crypto Funding Rates?

Let’s give this two tries. One for the nerds and one for everyone else.

For nerds: A crypto funding rate is a small percentage of your position’s value that you pay to (or receive from) traders on the other side of the trade.

For normal people: Funding rates keep the crypto perpetuals’ prices closer to spot prices.

Which one do you like better? Non-nerd? Fine, we’ll stick to that then.

If you didn’t know this already, spot prices are not equal to perpetual prices(don’t worry, we were confused the first time as well).

The funding rate is what keeps it all together.

Without funding fees, the price of the perpetual contract would disconnect from the spot price. Funding fees restore order to the trading universe.

In order to truly understand funding rates, you’ll need to understand futures and perpetuals as well.

If you’re comfortable with perps, just skip it to the real meat. But if you aren’t, we recommend reading the next section.

Sounds good? Let’s dig in and figure this funding rate stuff out together. Don’t worry — it’s not as confusing as it might sound.

Crypto Perpetuals, Explained

In a traditional crypto futures contract, two traders agree to buy and sell a crypto asset on or before a future date. Simple enough.

It’s like when you make a deal with your bowling buddy to sell him your spare bowling ball for $50 next Thursday when he gets paid. Both parties know the date and the price. If there’s a nationwide bowling ball shortage and the value of bowling balls shoots up to $200, it doesn’t matter. A deal is a deal.

There are three parts to this futures deal:

• Item and quantity: One bowling ball (the asset or commodity)
• Price: $50 for one bowling ball (the future price)
• Date: Next Thursday (the expiry date)

This is a physical settlement because you’ll deliver one real-world bowling ball next Thursday in exchange for $50 cash.

What we explained above is a futures contract but crypto trading often uses perpetual contracts instead.

Perpetuals act like futures contracts, but they don’t expire. Ever. They keep going and going and going. And they can do this through something called crypto funding rates.

Basically, one side of the trade pays the other side of the trade to keep this thing going, umm, perpetually.

Now, let’s look at a crypto example with Perpetual Swaps.

Let’s say you buy a Bitcoin futures contract today at $100,000. On the contract expiration date, the $BTC spot rate has risen to $102,000, meaning that’s what you could sell it for right now. That’s $2,000 in earnings (you genius). Of course, it could have gone the other way, too. The Bitcoin price could have fallen to, say, $95,000 by the expiration date. Now, you’re down $5,000. Yeah, you can lose money with futures too. Buuuut — what if you never had to take delivery of the Bitcoin? Maybe you weren’t wrong about the price direction, just a bit early. Well, that’s where crypto perpetual contracts come in, also called perpetual trading, perpetual swaps, or just perpetuals. The cool kids call them perps. All the same thing. You can still bet on the future price, but you don’t ever have to take delivery, and the contract never expires. Perpetual trading is popular because it’s waaaay easier than traditional futures trading, and you can bet on the price of all sorts of weird cryptos. Perpetual futures trades are just a bet on price, whether up or down.

• A long position is a bet on the price going up
• A short position is a bet the price will go down.

You can keep a perpetual contract open as long as you want — or as long as you can afford it. Remember those funding rates? Yep. There’s a cost to holding a position that’s on the opposite side of the market sentiment. We’ll get into how that works next.

What are Crypto Funding Rates, and How Do They Work?

A crypto funding rate is a small percentage of your position’s value that you pay to (or receive from) traders.

Funding rates can be positive or negative.

• The funding rate is positive when the perpetual is trading above the spot price. Long traders pay a fee to short traders.
• The funding rate is negative when the perpetual is trading below the spot price. In this case, shorts pay a fee to longs.

When perps price is greater than spot price, it means there is a decent amount of leveraged bets in the market.

If the perps price is much much higher than the spot price = lots of leverage in the market. Simple.

This is probably the only thing you need to understand about funding rates.

If you’re good with this, you’ll understand the rest. Trust us.

How Are Crypto Funding Rates Related To Market Sentiment?

If you’ve read through the article and are still feeling kinda lost, let us help you.

All that stuff doesn’t reallymatter (what it is, how it’s calculated etc.).

What matters is how you can use funding rates for investing.

Funding rates are basically a thermometer for the market (aka how hot or cold it is).

• Negative Funding Rates: The market is betting prices will go down
• Neutral Funding Rates: The market is betting prices will stay flat
• Positive Funding Rates: The market is betting prices will go up

If you remember correctly, positive funding rates also means there’s lots of leverage in the market (perps price > spot price by a lot).

And obviously, lots of leverage is never good for the market.

Hence, when funding rates are crazy high, it’s a sign that a pullback is coming.

What number is exactly “high funding rates”? Around 0.05%-0.08%

Take the massive pump leading into March as an example…

As the price surged, people got greedy and started to take on leverage – pushing funding rates to almost 0.08% at one point!

Then, the music stopped.

Prices tanked and funding rates spent the next month resetting back to neutral.

It was rough. And getting caught in these crossfires can be painful!

…but here’s the silver lining:

When the funding rate resets, inflated prices get smacked back to reality, giving us all an opportunity to buy-in before a new wave of demand hits.

So, next time the market is pumping and you feel the urge to ape in:

Remember to check the funding rates on Coinglass first. 👇

That’s the number you want to keep an eye on: ($BTC’s funding rate on Binance)

• 0.01% is neutral
• Anything above 0.05% is “get ready for pullback time”

Calculating Funding Fees

A basic funding fee looks something like this: Position size X the funding rate.

So, if you open a $20,000 position to go long Bitcoin and the funding rate is positive at 0.015%, you’ll pay $3 to keep that position open for 8 hours.

This might not seem like a lot but let’s say you keep your perpetual position open for 10 days, you will have to pay $90 bucks in funding fees (assuming funding rate stays constant at 0.015%).

If the funding rate is negative, the shorts pay the longs instead. So, let’s take the same example (20,000 position to go long Bitcoin) but the funding rate is -0.015%. Then, you will be getting paid $3 every 8 hours.

If the funding rate is negative, you will always get paid to hold a long position. Somebody is always getting their palm greased by the other side.

Go into a perpetual contract knowing this: You’ll either pay a funding fee or receive one, and it might change over the course of your trade. If the perpetual is close to the spot price, the funding rate is lower because not as much incentive is needed to bring that wayward perp price back in line.

But here’s some good news: You don’t have to calculate funding rates at all. Just relax and let the computers do that for us. You’ll see the funding rate right on your trading screen. Easy.

Funding Fees vs Trading Fees

If you’re wondering what’s the difference between funding and trading fees, here it is:

• Funding fees go to other traders.
• Trading fees go to the exchange.

The funding rate is calculated for you and displayed on your trading dashboard.

You won’t need a funding rate calculator or the fancy calculator wristwatch you got in eighth grade — unless you really want to use it.

How Do People Make Money Off Crypto Funding Rates?

There are a few ways to put this funding rate thing to work for you. However, none of this is financial advice, okay? After all, you might lose all your money. You probably will, in fact.

Below is a hypothetical example. Put your hypothetical hard hat on; to maximize the trades, you’ll need to use leverage.

Funding Rates In Action

Let’s say a $BTC perp is trading at $100,000 on Exchange A against $98,000 in the spot market. The funding rate is 0.02%. That’s a positive rate. So, going short will earn a funding fee, right? Righto! The longs pay the fee to shorts.

Assume all these figures stay unchanged for the next 24 hours with funding fees paid every 8 hours. Here’s what you could do to (hypothetically) make money from the divergence:

• You can open a short position worth $10,000 in the $BTC perp market and earn:
• Without leverage: ($10,000 x 0.02%) = $2 per 8 hours ($6 per day)
• With 5x leverage: $30 per day.
• With 10x leverage: $60 per day.

Now, of course, this is hypothetical. Prices and funding rates will shift throughout the day and hence the funding fees will also vary.

Cash And Carry

Things might get confusing so continue with caution. This is one of the most common trading strategies in crypto that most people don’t know about. It’s usually done by the massive trading firms. The strategy is delta-neutral which means there is no risk in this trade. Let’s break it down:

Assume $BTC is trading at $100,000. The funding rate is 0.02% and is paid every 8 hours (stays consistent throughout the week for the sake of the example).

• You buy Bitcoin in the spot market (let’s say, worth $10,000)
• You short the same amount in the perpetuals market (again, worth $10,000)

This strategy has no risk because you’re buying both sides of the trade - both long and short.

Let’s Bitcoin falls to $95,000. You will make 0 profit because you lose $5,000 from your long bet but make $5,000 from the short bet.

Similarly, if the price increases to $105,000, you will make 0 profit because you lose $5,000 from short bet but make $5,000 from your long bet.

Hence, regardless of the price movement, you will not make any profits from your trades.

The only place you will make money is from the funding rates.

Now, remember that you have a short $10,000 position and funding rate is 0.02%.

Remember, you’re not paying the funding rate. Those greedy longs are paying you because the funding rate is positive). Hence, you are making $2 per 8 hours. Extend that to a week, you are making $42/week.

Mind you, you are making $42/week with absolutely no risk. Isn’t that wild?

This trade is usually done with massive volume to make sense. That’s why most of the big dogs do it and the rest of us haven’t even heard of it.

To Sum It Up

• The crypto funding rate helps balance the perpetual rate to the spot price of a specific crypto.
• Extremely high positive funding rates = higher chance of a pullback
• Positive funding rate: Longs pay short the funding fees
• Negative funding rate: Shorts pay long the funding fees
• Funding fees = Position Size * Funding rate
• Funding fees goes to the traders while trading fees goes to the exchange
• Best place to find funding rates in CoinGlass

Frequently Asked Questions