Funding Rate

In this section, we define the Funding Rate, its constituent components, and how it is used.

Purpose of the Funding Rate 

The Funding Rate is used essentially to force convergence of prices between the Perpetual Futures Market and the actual underlying commodity.

Why is the Funding Rate Important?

In traditional futures contracts, settlements occur on a monthly or quarterly basis - depending on the contract specifications. At settlement, the contract price converges with the spot price, and all open positions expire. Perpetual contracts are widely offered by crypto-derivative exchanges, and it is designed similar to a traditional futures contract. Albeit, perpetual contracts offer a key difference. 

Unlike conventional futures, traders can hold positions without an expiry date and do not need to keep track of various delivery months. For instance, a trader can keep a short position to perpetuity unless he gets liquidated. As a result, trading perpetual contracts are very similar to trading pairs on the spot market.

In short, perpetual contracts never settle in the traditional sense. As such, crypto-exchanges created a mechanism to ensure that contract prices correspond to the index. This is known as Funding Rate.

What is the Funding Rate?

Funding rates are periodic payments either to traders that are long or short based on the difference between perpetual contract markets and spot prices. When the market is bullish, the funding rate is positive and long traders pay short traders. When the market is bearish, the funding rate is negative and short traders pay long traders.

LBank takes no fees for Funding Rate transfers; these are directly between traders.

On the LBank futures trading platform, the timing for calculating funding fees varies by cryptocurrency. You can go to the futures trading interface, select the cryptocurrency, and click on the funding rate and countdown timer in the top right corner. A pop-up will show the funding rate collection interval for that particular cryptocurrency, as shown in the image below.

How to Calculate the Funding Amount?

Funding is calculated as:

Funding Amount=Nominal Value of Positions* ×Funding Rate

*Nominal Value of Positions = Mark Price x Size of a Contract

What Determines the Funding Rate?

There are two components to the Funding Rate: the Interest Rate and the Premium. The Premium particular is why the price of the Perpetual Contract will converge with the price of the underlying instrument. 

LBank uses a flat interest rate component, with the assumption that holding cash equivalent returns a higher interest than BTC equivalent. The difference is stipulated to be 0.03% per day by default (0.01% per funding interval)* and may change depending on market conditions such as the Federal Funds Rate.

There may exist a significant difference in price between the Perpetual Contract and the Mark Price. In such instances, a Premium Index will be used to enforce price convergence between the two markets. It is calculated separately for every instrument, and the formula is below:

Premium Index(P)=Max(0, Impact Bid Price−Mark Price)−Max(0, Mark Price−Impact Ask Price)/Spot Price

Impact Bid Price=The price to Buy the Notional Impact

Impact Ask Price=The price to Sell the Notional Impact

The Notional Impact is the amount in USDT available to trade with 200 USDT worth of margin; at default levels, this is 4,000 USDT.

LBank calculates the Premium Index every second, and takes a Time-weighted average across all indices to the Funding Time. 

The Funding Rate formula itself is:

Funding Rate (F) = Premium Index (P) + clamp(0.01% - Premium Index (P), 0.05%, -0.05%)

In other words, as long as the Premium Index is between -0.04% to 0.06%, the Funding Rate will equal 0.01% (the interest rate).

If (Interest Rate (I) - Premium Index (P)) is within +/-0.05% then F = P + (I - P) = I. In other words, the Funding Rate will be equal to the Interest Rate.