What is the Funding Rate? A Complete Explanation of the Funding Mechanism for Perpetual Contracts

Funding rate refers to the periodic funding fee exchanged between long and short position holders in perpetual derivative contracts. This mechanism is an important tool to bring prices back to fair levels when the market overheats or cools down. Understanding the funding rate allows traders to accurately grasp the actual cost or benefit of their positions.

Basic Mechanism of the Funding Rate

The funding rate can be checked in real-time on the derivatives trading page and fluctuates until the next funding timestamp. Typically, if settled every 8 hours, the funding fee calculated from midnight (UTC) to 8 a.m. (UTC) is exchanged at 8 a.m. Similarly, the fee calculated from 8 a.m. to 4 p.m. is exchanged at 4 p.m.

This regular settlement cycle allows traders to anticipate how much cost or profit their positions will incur in the future.

Components of the Funding Fee: Interest and Premium Index

The funding rate mainly consists of two elements:

1. Interest (I) — This is the basic daily interest rate set by the platform, usually fixed at 0.03% per day. For an 8-hour settlement cycle, this is divided into three parts, each 0.01%. However, some trading pairs (such as USDC/USDT or ETH/BTC/USDT) may have the interest rate set to 0% by default.

2. Premium Index (P) — This indicates how much the perpetual contract is trading at a premium or discount relative to the mark price. When the market is overheated with strong longs, the premium increases; during bearish conditions, it becomes a discount. The premium index is calculated using the concept of Impact Margin Notional, which measures the depth of the order book.

Calculation Formula and Practical Application

The complete formula for the funding rate (F) is:

F = Clamp [Average Premium Index (P) + Clamp (Interest (I) − Average Premium Index (P), 0.05%, −0.05%), upper limit, lower limit]

In simple terms, it adds the premium index to the interest rate, then constrains the result within predefined upper and lower bounds. The calculation is performed every minute, using a TWAP (Time-Weighted Average Price) over N hours to determine the values of interest rate and premium index.

The resulting funding rate is multiplied by the trader’s position size to determine the amount payable or receivable at settlement time.

Logic for Calculating the Premium Index

The premium index is calculated as:

P = [Max(0, Impact Bid Price − Index Price) − Max(0, Index Price − Impact Ask Price)] / Index Price

Impact Bid Price is the average execution price when the buy side executes Impact Margin Notional, and Impact Ask Price is the reverse. These values are automatically derived from the order book depth.

Furthermore, the average premium index is calculated using a weighted average algorithm. For an 8-hour funding cycle, it sums all premium index values from the previous settlement to the current time, applying a time decay coefficient, then divides by the total coefficient. This weighting gives more importance to recent market data, reflecting the latest market conditions more strongly.

Upper and Lower Limits of the Funding Rate

During significant market fluctuations, the platform temporarily adjusts the upper and lower limits of the funding rate to prevent extreme price divergence. Under normal conditions, these are set as:

Upper limit = min [(Initial Margin Rate − Maintenance Margin Rate) × 0.75, Maintenance Margin Rate]

Lower limit = −min [(Initial Margin Rate − Maintenance Margin Rate) × 0.75, Maintenance Margin Rate]

If a large price gap occurs between futures and spot markets, the coefficient 0.75 is dynamically adjusted within the range of 0.5 to 1.0. This helps prevent excessive funding rate spikes and supports proper price formation.

Market Phase-Specific Funding Rate

The method of calculating the funding rate varies depending on the market phase:

During normal auction periods, the standard calculation described above applies.

In the initial market phase (call auction period), the funding rate is set to zero, and neither the interest nor the premium index participate in the funding fee calculation.

In subsequent continuous auction periods, the funding rate is fixed at 0.005%, often settled on a shorter cycle of 4 hours.

By understanding the funding rate, traders can better grasp the cost structure of perpetual contracts and manage their positions more strategically.