Derivatives Funding, within crypto markets, refers to the periodic payments exchanged between the long and short positions of perpetual swap contracts. Its purpose is to align the contract’s price with the underlying spot asset price, preventing sustained divergence and maintaining market equilibrium without a fixed expiry date.
Mechanism
The mechanism involves an algorithmically determined funding rate, calculated based on the price difference between the perpetual swap and its underlying index price. If the perpetual price is higher than spot, longs pay shorts; if lower, shorts pay longs. These payments occur at regular intervals, typically every eight hours, directly between counterparties without exchange intervention.
Methodology
Derivatives Funding functions as a crucial arbitrage incentive and a gauge of market sentiment. Traders employ strategies that consider funding rate differentials to execute cash-and-carry trades, capitalizing on price discrepancies while hedging directional exposure. The architectural design of these systems ensures transparent, predictable payment cycles for all participants.
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