Funding Payments Definition
Funding payments refer to the periodic payments made to long or short positions in the perpetual contracts market in the cryptocurrency context. The transaction, which can be either received or paid by a trader, is meant to ensure that the price of the perpetual contract stays close to the underlying cryptocurrency price.
Funding Payments Key Points
- Funding payments are made between traders rather than the exchange platform.
- They occur every eight hours on most trading platforms.
- The level of payment is determined by the difference between the contract and spot markets.
- Traders either receive or pay funding depending on the state of their trading position.
What are Funding Payments?
Funding payments serve as a major component in the trading of cryptocurrency perpetual contracts – these are a variant of futures contracts with no expiry or settlement date, essentially allowing a trader to maintain a position indefinitely. In an ideal situation, the price of a cryptocurrency in the spot market (or the price at which it can currently be bought or sold) should be close to the perpetual contract prices. This is where funding payments come into play – they work as an incentive or disincentive that keeps the contract prices anchored to the spot prices.
How do Funding Payments function?
The function of funding payments is closely linked with the state of the market. Assume trading is occurring in a bullish market, and the perpetual contract prices are higher than the spot prices. In this scenario, the funding payment rate is positive, leading long position holders to pay short position holders. The logic behind this is that when the contract value is higher than the spot price, there are more longs on the market who are hoping for the price to increase. Therefore, to balance out this disparity, longs have to pay a funding fee to shorts.
Conversely, when the market is bearish and the contract price is lower than the spot price, the funding payment rate is negative. Short position holders end up paying the fee to long position holders.
When are Funding Payments incurred?
Typically, funding payments are made every eight hours on most cryptocurrency derivative exchange platforms. Irrespective of market conditions at the time, if a trader holds a position during one or more of these times, they’re subject to receiving or paying funding fees.
Where are Funding Payments utilized?
In crypto derivative markets, funding payments are utilized exclusively in the perpetual contracts markets. The contract sector is essentially a market for speculators wishing to take advantage of short-term market oscillations and it’s where most of the leverage trading takes place.
Who uses Funding Payments?
Funding payments are used by both short-term and long-term traders. For those taking on long positions, funding payments can sometimes represent a significant cost, especially during bullish market conditions. Conversely, short-sellers can often earn a substantial income during such periods as they receive the funding payments. However, it’s important to note that these payments can quickly reverse with a change in market sentiment.
Why are Funding Payments significant?
Funding payments play a key role in aligning the price of perpetual contracts with the underlying spot market, providing a mechanism to ensure the contract price doesn’t deviate significantly from the spot price. Furthermore, depending on the direction of the market and the positions traders hold, funding payments can either be a cost or a profit source for the traders.
