Funding rate

A periodic payment exchanged directly between long and short holders of a perpetual contract, sized to keep the contract's price tethered to the underlying spot price. Whichever side is crowded pays the other.

Definition

The funding rate is the mechanism that stops a perpetual contract drifting away from the asset it tracks. A perpetual has no expiry date and therefore no settlement to pull its price back in line, so the protocol charges the side that is pushing the price and pays the side holding it back.

When the contract trades above spot, longs pay shorts. When it trades below, shorts pay longs. The payment goes between traders, not to the exchange.

How it changes behaviour

The rate is an incentive, and it works. Paying to hold a crowded position makes that position less attractive; being paid to sit on the unpopular side attracts capital to it. Prices converge because it becomes profitable to make them converge.

That means the rate is also a signal. Persistently expensive funding on one side is the market telling you how one-sided the positioning has become, and one-sided positioning is what makes a violent unwind possible.

The cost you actually pay

Funding is charged per interval, and the interval and calculation differ by exchange. Small per payment, it compounds for anyone holding a position for days rather than hours, and it is deducted from the collateral backing the position, which moves the liquidation price closer.

The rate is not fixed and can flip direction while you hold. A position that was being paid to exist can start paying instead, without anything visible changing on the chart.

Where you will run into it

On the market header of any perpetual DEX, in the funding history of an open position, and as a component of strategies built to earn the rate rather than the price move, which are exposed to it reversing.