The funding rate is a unique feature for the Perpetual contract to reduce the price difference between the Perpetual contract market and the Spot market, and the rate is based on the position value. It can influence the position PNL or even the liquidation price.
1. Settlement of Funding Fee
Unlike a Delivery contract, the Perpetual contract does not require delivery at maturity. Users can hold the Perpetual contract in a long turn. However, a mechanism is needed to ensure the consistency between the contract price and the Spot one, the funding mechanism. The funding mechanism can make the Perpetual contract price anchor to the spot one.
The funding fee is settled between users who go long and those who go short; the platform will not charge for it. When the funding rate is positive, the long pay the short; if the rate is negative, the short pay the long.
2. Funding Fee's Influence on Position PNL and Liquidation
A. Background
a. Influence on Position PNL
When settling the funding fee, there will be two situations:
- User A needs to pay the funding fee, and then the position will bear losses.
- User B can receive the funding fee, and then the position will gain profit.
As we can see, the settlement of the funding fee influences the position PNL.
b. Influence on Liquidation
As mentioned above, when the user pays the funding fee, the position will bear losses and the margin will therefore be reduced. If the margin keeps decreasing until below the maintenance one, the liquidation will be triggered. Although the funding fee will not directly lead to liquidation, it will influence the margin amount.
Please pay attention that if you keep paying for the funding fee, the position margin will be less than the maintenance one, causing liquidation.
B. Calculation:
Funding Fee = Position Value * Funding Rate
The position value is determined by the mark price at the settlement time.
Take BTC Perpetual/USDT as an example, if user A holds a long position of 0.01 BTC, and the mark price is $5,000, and the funding rate is 0.01% when at the settlement time, then:
Position Value = 0.01 (Quantity) * 5,000 (Mark price) = 50 USDT
Funding Fee = 50 (Value) * 0.01% (Funding rate) = 0.005 USDT
When the funding rate is positive, the long pay the short, user A needs to pay 0.0005 USDT, however, user B with the short position of 0.01 BTC will receive 0.0005 USDT.
Please note that in COIN-Margined contract, Position Value = 1/Mark Price x Quantity
C. How to Control Position Risk
The calculation of the funding fee is positively correlated with the position value -the greater the position value, the more funding fee. If your position value is great, please pay attention to the influence of the funding settlement on positions.
Tips:
a. Close positions before the settlement time
Perpetual contracts are settled every eight hours at 04:00, 12:00, and 20:00 (UTC). If you are still holding positions at the settlement time, you will need to pay or receive the funding fee.
>>Check the funding rate history of your contract.
b. Control leverage when placing an order
Newbies are recommended to control the leverage within 5x to lower the position risk.
>>Learn more about risk control.
3. How to arbitrage through a funding mechanism?
Actually, we can arbitrage by receiving funding fees. But how to do that?
To arbitrage from the funding fees, we can open short positions of Perpetual contract and long positions of Spot, Margin, or Delivery contract at the same time. For example, combine Perpetual contract with Spot or Margin orders, or the combination of Perpetual contract and the Delivery one, etc. To learn more details, please stay tuned for our upcoming articles.
No matter which arbitrage strategies, please noted that each strategy has its own risks; just select the one that suits you most to cultivate your own investment principle and control risks.
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