The funding rate that is derived (implied) from the difference between perpetual contract markets and spot prices. Funding rates are periodic payments either to traders that are long or short based on the difference between the two market positions. Based on open positions, traders have to either pay or receive funding. A funding rate implies a periodic payment or tax for which the paying party is determined depending on if traders are long or short. When funding is positive, longs pay shorts, and shorts pay longs when funding is negative.

Perpetual futures contracts are similar to traditional futures contracts but without a certain expiration date. The funding rate is a mechanism that exchanges use to derive trading prices for perpetual futures contracts as close as possible to the underlying’s spot price. Under this mechanism, periodic funding payments are made between long position holders and short position holders depending on whether the perpetual future’s price is above or below the underlying’s spot price.

However, calculating funding rates in crypto perpetual contracts is not an easy process since funding rates always change due to a variety of factors such as the price of the underlying asset, the interest rate quoted in the funding currency, and market liquidity. The calculation process involves determination of the funding rate at certain time intervals. More specifically, this entails tracking supply and demand on the exchange and then establishing a funding rate that can maintain equilibrium. The inferred funding rate is then used to balance trader positions without exchange intervention by crediting or debiting crypto accounts, as defined by respective positions (size and direction).

The funding rate is designed to ensure fair trading for all market participants. It also curbs down potential market manipulations or price distortions due to large trading positions. In other words, it prevents large, and impactful price divergences, especially in volatile markets. The periods (time intervals) and corresponding rates are calculated differently on different venues/ exchanges, but several venues aggregate this information.

These rates are also known as market funding rates.