Bitcoin, the most famous digital currency started to wake up since a halving occurred in May 2020. The future appears to be very promising and the funding rates of digital assets are playing a protagonist role in this massive game. This article is solely based on what is the funding rate and the way it affects cryptocurrencies in the present time and the near future.
The funding rate: What is it and why is it so important?
It is important to understand some primordial facts before going deeper on what the funding rate is and why it is so important for traders: first, the funding rates are payments that can be long or short established on remarkable differences between perpetual contract markets and spot prices. Once the market is confident, the funding rate is positive and long traders pay short traders. When the market is pessimistic the funding rate is negative and short traders pay long traders.
Small situations may occur regarding the spot price and future price linking to the same instrument. This can cause a divergence; these divergences can be removed once the futures conclude. This event assures the holder of a future the same amount at expiration.
Temporary divergences
The futures market is very solid and these divergences have a temporary tendency depending on these futures market. If the efficiency of the futures market and experienced traders make differences or disagreement leading to arbitrage between futures and spot prices the divergence will be quickly removed without major problems.
A whole new set of categories regarding futures have seen the light thanks to digital assets, these perpetual swaps are linked to the spot price of the same underlying asset, these With digital assets, exchanges on which they trade have provided a new kind of futures: perpetual swaps. These tradable instruments’ main mission is to copy the spot price without detaining it.
But there are differences; the most relevant one is perhaps that they never expire, so the investors are properly allowed to hold a position for the time they believe is right.
Consequently, the price of the perpetual swap must be balanced and in line with the spot price of the instrument. Investors pay to hold a position; being the prices lower than the spot price. This eradicates the possibility of paying them if they are holding a perpetual swap position that would be, in other cases, with a higher price of the same underlying asset.
This mechanism is called the funding rate. Its mission is to create daily adjustments to the market and its movements. If the market is moving with strength, and the volatility risk is high, the price of the perpetual swap will show discrepancies toward its low volatility periods. This movement will lead to a funding rate to generate a reduction and close the breach between the futures and the spot price.
By Jenson Nuñez
