How is the funding fee of perpetual contract calculated?

Understanding Funding Fees in Perpetual Contracts

Perpetual contracts, also known as inverse futures, are a popular type of derivative in the cryptocurrency market. Unlike traditional futures contracts that have an expiry date, perpetual contracts remain open indefinitely. To align the prices of perpetual contracts with their underlying assets, funding fees are introduced as a mechanism to maintain price parity.

Perpetual Contract Funding Fees

Funding fees are paid or received by traders based on the difference between the perpetual contract price and the funding rate. The funding rate is typically calculated every 8 hours and adjusted to ensure that the contract price closely tracks the spot market.

Methodology for Calculating Funding Fees

Step 1: Determine Market Sentiment

The funding rate reflects the market's sentiment towards a particular asset. If there are more long positions (bets that the price will rise) than short positions (bets that the price will fall), the funding rate will be positive. Conversely, if there are more short positions, the funding rate will be negative.

Step 2: Set Funding Threshold

A positive funding rate encourages longs to close their positions or shorts to open their positions. Conversely, a negative funding rate discourages shorts from opening positions or encourages longs to close their positions.

Step 3: Funding Rate Calculation

The funding rate is typically set on an 8-hourly basis and calculated using the following formula:

Funding Rate = (Longs Interest Rate - Shorts Interest Rate) / 8

Longs Interest Rate: This rate is calculated based on the prevailing bid price and represents the borrowing cost for longs.

Shorts Interest Rate: This rate is calculated based on the prevailing ask price and represents the borrowing cost for shorts.

Step 4: Apply Funding Fees

The funding fee is applied to each trader's account based on their position size and the funding rate. Traders who hold long positions pay funding fees to traders who hold short positions. Conversely, traders who hold short positions receive funding fees from traders who hold long positions.

Example of Funding Fee Calculation

Let's say the perpetual contract price for Bitcoin (BTC) is $20,000, while the spot price is $19,980. This indicates that the perpetual contract price is slightly higher than the spot price.

Assuming the longs interest rate is 0.01% (0.0001) and the shorts interest rate is 0.002% (0.00002), the funding rate would be calculated as:

Funding Rate = (0.0001 - 0.00002) / 8 = 0.0000125

This positive funding rate encourages traders to open short positions and close long positions, potentially bringing the perpetual contract price closer to the spot price.