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BTC perpetual futures are special types of BTC futures contracts with no expiry dates. Since they have no expiry date, exchanges need a mechanism to ensure that the Bitcoin futures prices and the price of spot Bitcoin don't diverge too much from each other. This mechanism is called the BTC funding rate, and it’s essential when trading perpetuals based on any asset. This article will introduce you to how funding rates work when trading Bitcoin, how traders make money off them, and the best exchanges to trade Bitcoin perpetuals.
Bitcoin Funding Rate Key Takeaways:
- Positive Bitcoin funding rates: Traders who are long BTC will pay traders who are short BTC.
- Negative Bitcoin funding rates: Traders who are short BTC will pay traders who are long BTC.
What Are BTC Funding Rates?
A futures contract is simply an agreement between two parties to buy or sell a specific asset at a set future date for a predetermined price. Futures contracts are called derivatives because their value derives from the value of an underlying asset. The buyer of the contract is in a long position, meaning they benefit if the underlying asset increases in price, and the seller is in a short position, meaning they benefit if the underlying asset decreases in price.
A traditional futures contract has an expiration date where the seller transfers possession of the underlying asset to the buyer, while a perpetual futures contract has no expiration date. As they have no expiration date, perpetual contract prices would have the possibility of varying from the base price of the underlying asset.Crypto funding rates are the mechanism that keeps the price of the perpetual contract tied to the base asset price.
If the futures price surpasses the base asset price, traders with long positions pay the funding rate to the traders with short positions. If the futures price ends up lower than the base asset price, the traders with short positions pay the funding rate to those with long positions. This percentage is the funding rate. The funding rate when trading Bitcoin perpetuals depends on the exchange you use and the trader positioning on that exchange.
BTC Perpetuals And Funding Rates Explained
Bitcoin perpetuals enable you to profit both when the market goes up by taking long positions and when the market goes down by taking short positions. Compare this to buying spot Bitcoin, where you can only profit when the market goes up. Furthermore, exchanges let you use leverage to amplify your potential profits when trading BTC perpetuals (and losses too).
If the funding rate is positive, it implies there are too many bullish investors "longs," and the funding rate gets paid to the bearish traders "shorts." If the funding rate is negative, the bearish traders are the ones who pay the bullish investors. Exchanges calculate the funding rates multiple times each day, generally between 4 and 8 hours. You will collect or pay funding rates at each interval if you hold an open Bitcoin perpetuals contract.
How Do People Make Money Off BTC Funding Rates?
Traders employ a variety of strategies to profit from BTC funding rates:
BTC Funding Rates Arbitrage
Arbitrage is a trading strategy that exploits price differences between identical assets on different markets or exchanges. You can go long on one futures market and short on another to pocket the difference in funding rates. Using leverage increases the potential profit you can earn but also the losses, so be careful.
Here’s a typical example of a funding rate arbitrage strategy:
- Exchange A has a funding rate of +0.005% for BTC perpetuals.
- Exchange B has a funding rate of -0.002% for BTC perpetuals.
The funding rate difference between these two exchanges presents a potential profit opportunity. Here’s how to calculate it for a 24-hour period;
- Exchange A funding rate: +0.005% x 24 hours = 0.12% paid to shorts (positive implies long pays to shorts).
- Exchange B funding rate: -0.002% x 24 hours = 0.048% paid to longs (negative means shorts pay to longs).
With $20,000 of capital, you can open a short position on exchange A. Your profit potential is 0.12% of $20,000 = $24 daily. With 5x leverage, it becomes $120 (24x5), and with 10x leverage, it becomes $240.
With another $20,000 in capital, you can open a long position on exchange B. Your profit potential is 0.048% of $20,000 = roughly $10 daily. With 5x leverage, it becomes $50 daily, and with 10x leverage, $100 daily.
Net total revenue without leverage = $24+$10 = $34 daily. With 5x leverage, it’s $170 daily, and with 10x leverage, $340 daily before accounting for exchange fees.
The challenge with this strategy is that funding rates fluctuate significantly by the hour or day. Hence, you’ll have to actively monitor the funding rates on both exchanges to see if they still present an arbitrage opportunity. It’s not a strategy that you can just automate and forget.
BTC Cash And Carry
Cash-and-carry is a strategy that exploits pricing discrepancies. It involves taking a long position on an asset, BTC in this case, and simultaneously selling a futures derivative based on that asset.
Here’s a standard example of a BTC cash-and-carry trade;
- Assume 1 BTC currently trades for $19,700, and a BTC perpetuals contract is priced slightly higher, thus carrying a positive funding rate. You can buy one BTC and simultaneously sell a perpetual for that BTC to hedge your bet.
- Since the funding rate is positive, you’ll be paid for your short position. Assume a funding rate of 0.002%. The daily profit potential is (0.002% x 24 hours) of $19,700= $9.50 daily.
The downside of a cash-and-carry trade is that you can't use leverage for the spot side of the trade. You must have the cash on hand to fund that original BTC purchase.
BTC Market Sentiment
Funding rates serve as a proxy for judging general market sentiment. If BTC funding rates are very positive, it implies that traders overwhelmingly believe that the price will rise in the near term. On the other hand, if funding rates are mostly negative, it implies that most traders believe the BTC price is headed for a drop.
For instance, you may think that the market sentiment at a point is too optimistic and will eventually correct itself to remain stable– in this case, short BTC, and you’ll profit if your conviction rings true. Alternatively, you may think that a very positive funding rate means the price of BTC will definitely rise in the near term– buy some coins and profit if your belief rings true.
There’s no trick with this strategy. It’s simply you, as a trader using funding rate as a yardstick to measure market sentiment and act on that.
Where To Trade BTC Perpetual Contracts
Trading pairs are assets that you can trade for each other on an exchange. They're helpful because you can purchase some cryptocurrencies only with other cryptocurrencies. With a trading pair, you don't have to sell one cryptocurrency for fiat and, in turn, buy the other cryptocurrency– you can just swap it directly.
Trading pairs allow you to trade BTC perpetual contracts with leverage but using another cryptocurrency as collateral. The collateral is often a stablecoin such as USDT or USDC.
Different exchanges support different trading pairs for BTC perpetuals contracts. Here are examples of various exchanges and the trading pairs they offer;
Deciding the best trading exchange depends on many factors, including your location, transaction fees, whether you prefer a centralized or decentralized exchange, etc. For instance, due to regulatory compliance issues, many exchanges don’t offer perpetual contracts to U.S. citizens, including dYdX.
Different exchanges also have different limits on leverage. For instance, dYdX has a 20x limit for perpetual contracts, while Bybit offers a much higher 100x limit. If you’re comfortable with trading with very high leverage, Bybit will be the preferable option.
Differences in transaction volume between exchanges affect the funding rate. Hence, you can take advantage of these differences to earn profit using the arbitrage or cash-and-carry strategy.
2. Bybit
Bybit BTC Leverage And Margins
Bybit offers up to 100x leverage, and you must post initial margin and maintenance margin. It charges a 0.06% fee for perpetual trades. For instance, a $200 perpetuals trade would rack up a $0.12 fee ($200x0.06/100). Leverage magnifies your trading fees by the multiple of your leverage. In that example, a 10x leverage makes your fee become $0.12x10= $1.2.
Bybit calculates funding rates for BTC perpetuals and exchanges them directly between buyers and sellers every 8 hours.
- Funding Rate (F) = Premium Index (P) + clamp (Interest Rate (I) − Premium Index (P), 0.05%, −0.05%).
This exchange's maintenance margin for BTC perpetuals is 0.5%.
3. dYDX
dYdX BTC Leverage And Margins
dYdX allows a maximum of 10x leverage for BTC perpetuals. It does not charge fees for users with 30-day trading volumes below $100,000. Above that limit, the fee is between 0.02% and 0.05%. The bigger your trades, the lesser the fees you incur. Its maintenance margin requirement for BTC perpetuals is 3%.
This exchange pays out funding rates every 8 hours. The formula to calculate it is:
- Funding Rate = (Premium Component / 8) + Interest Rate Component, where Premium Component = (Max(0, Impact Bid Price - Index Price) - Max(0, Index Price - Impact Ask Price)) / Index Price.
BTC Funding Rates Taxes
Depending on your tax jurisdiction, funding rate payments may count as taxable income. For example, the American Internal Revenue Service (IRS) considers cryptocurrency as property that residents need to report on their tax forms and pay the specified rate.
Likewise, any profit you make from BTC perpetuals will likely constitute ordinary income that you need to pay tax on. On the other hand, you will be able to offset trading losses against other trading gains income to lower your tax burden.
It’s advisable to speak to a qualified tax attorney and get a professional opinion on what should count as taxable income and what should not. It’s just essential to know that because cryptocurrency isn’t fiat doesn’t make it exempt from taxation.
Final Thoughts On BTC Funding Rates
Most crypto users, especially new ones, may not know what a funding rate is. It can be a complicated topic for people that try to understand, but we’ve tried to break it down as simply as we can.
Funding rates are what keep the price of BTC perpetuals tied to the base BTC price, allowing traders to speculate on BTC prices without actually owning the cryptocurrency. We’ve explained how you can earn profits off funding rates and listed some exchanges that let you trade BTC perpetuals and get funding rate payments.
Frequently Asked Questions
The traders pay the BTC funding rates to keep perpetual contracts tied to their base asset price. If the funding rate is positive, the bullish traders “longs” pay to the bearish traders “shorts,” and vice versa if the funding rate is negative.
Unfortunately, regulatory issues prevent crypto exchanges from offering BTC perpetuals to U.S. residents.
There’s no almighty formula for calculating funding rates. Different exchanges use different parameters to determine theirs, some of which we’ve shown you in this article.
The price of a perpetual contract might reduce drastically from the base asset price during volatility and cause losses, more so if leveraged.
BTC perpetual futures work by allowing a buyer and seller to come together to speculate on the price of Bitcoin or hedge their positions. The perpetuals are tied to the base Bitcoin price by funding rates, so they allow buyers and sellers to speculate on the price of BTC without owning any BTC.
