Funding Rate - How Perpetual Contracts Stay Aligned with Spot

TL;DR

Funding rate is a periodic payment between longs and shorts that keeps perpetual contract prices aligned with spot prices.

Positive funding → Longs pay Shorts (perp trading above spot)
Negative funding → Shorts pay Longs (perp trading below spot)
Typical rate: 0.001% to 0.01% per 8-hour period (very small)
Bounds: ±100 basis points (±1%) default, configurable per market
Payment interval: Typically hourly (rate calculated over 8 hours, paid in installments)

Why Funding Rate Exists

Perpetual contracts have no expiry date. Unlike traditional futures that settle at a fixed date, perps can trade forever. Without a mechanism to anchor them, the price could drift far from spot.

The problem:

Spot BTC: $100,000
Perp BTC: $105,000 (traders are bullish)

Without funding: Perp could stay at $105,000 indefinitely
With funding: Longs pay shorts → incentivizes selling → price converges

How Funding Actually Keeps Prices Aligned

Key insight: Closing a LONG = SELLING

When you OPEN a long:  You BUY the contract (pushes price up)
When you CLOSE a long: You SELL the contract (pushes price down)

The Complete Mechanism

Scenario: Perp at $105, Spot at $100 (5% premium)

Perp price too high ($105 vs $100 spot)
        ↓
Funding rate goes positive (+1%)
        ↓
Longs have to PAY money every hour
        ↓
Longs think "I don't want to keep paying"
        ↓
Longs CLOSE their positions
        ↓
Closing a long = SELLING
        ↓
More sellers than buyers
        ↓
Price goes DOWN toward spot

Three Forces at Work

1. Direct Cost Pressure

You're LONG $100,000
Funding: +1% per 8hr = $1,000 cost

"This is expensive, maybe I should close"
You close (SELL) → Price drops

2. New Position Incentives

Funding: +1%

Opening LONG: You'll PAY funding
Opening SHORT: You'll RECEIVE funding

"Why go long and pay? I'll short and get paid!"
More shorts = More SELLING = Price drops

3. Arbitrage

Perp: $105 (expensive)
Spot: $100 (cheap)

Arbitrageur:
1. SHORT perp at $105
2. BUY spot at $100
3. Collect funding (shorts receive)
4. Wait for convergence
5. Profit!

Arbitrage = SELLING pressure on perp = Price drops

Visual Flow

Perp trading ABOVE spot
        │
        ▼
Positive funding rate
        │
        ▼
Longs PAY shorts
        │
        ├─────────────────────────────┐
        ▼                             ▼
Longs close (SELL)          New shorts open (SELL)
        │                             │
        └──────────┬──────────────────┘
                   ▼
          SELLING PRESSURE
                   ▼
          Price drops toward spot
                   ▼
          Premium shrinks
                   ▼
          Funding rate drops
                   ▼
          Equilibrium: Perp ≈ Spot

The Core Formula

Premium (How Far Perp Is From Spot)

Premium = (Mark Price - Index Price) / Index Price

Example:

Mark Price (perp): $100,500
Index Price (spot): $100,000

Premium = ($100,500 - $100,000) / $100,000 = +0.5%

Funding Rate

Funding Rate = Average(Premium samples over interval)
             = Clamped to bounds (e.g., ±1%)

Who Pays Whom?

Funding Rate	Market Condition	Payment Direction
Positive (+)	Perp > Spot (bullish)	Longs PAY Shorts
Negative (-)	Perp < Spot (bearish)	Shorts PAY Longs
Zero (0)	Perp ≈ Spot	No payment

Payment Calculation

Payment = |Funding Rate| × |Position Notional|
        = |Funding Rate| × |Position Quantity| × Mark Price

Example:

Position: LONG 10 SOL
Mark Price: $100
Position Notional: 10 × $100 = $1,000
Funding Rate: +0.01%

Payment = 0.01% × $1,000 = $0.10
You PAY $0.10 to shorts

Bounds / Caps

Backpack's Default Bounds

rust

upper_bound_bps: 100   // +1% max
lower_bound_bps: -100  // -1% min

Bounds are per-market - different markets can have different caps:

Market Type	Typical Bounds	Why
BTC, ETH (very liquid)	±50-75 bps	Tighter caps, high liquidity
SOL, majors	±100 bps	Default
Smaller/volatile markets	±100-500 bps	Wider to allow natural price discovery

How Clamping Works

Calculated funding rate: +2.5%
Bounds: ±1%
Actual funding rate: +1.0% (capped)

Calculated funding rate: -3.0%
Bounds: ±1%
Actual funding rate: -1.0% (capped)

Why caps?

Protects traders from extreme costs
Prevents funding from becoming punitive
Maintains market stability in volatile conditions

Realistic Funding Rate Examples

Funding rates are typically very small:

Market Condition	Rate (per 8hr)	On $100k Position	Monthly Cost
Neutral	~0%	~$0	~$0
Normal	0.005%	$5	~$450
Slightly elevated	0.01%	$10	~$900
High	0.05%	$50	~$4,500
Very high	0.1%	$100	~$9,000
Max (capped at 1%)	1%	$1,000	~$90,000

The 1% cap is rarely hit. Most of the time: $5-50 per 8 hours on $100k.

Payment Timing

Backpack's Approach

Parameter	Typical Value
Funding Period	8 hours (rate calculated over this)
Payment Interval	1 hour (payments made this often)

How It Works

With FundingPaymentInterval strategy:

8-hour funding rate calculated: 0.08%

Paid in 8 hourly installments:
  Hour 1: 0.01% (0.08% ÷ 8)
  Hour 2: 0.01%
  Hour 3: 0.01%
  ...
  Hour 8: 0.01%

Total: 0.08%

Why hourly payments?

Smoother cash flow for traders
Less sudden impact than one big payment
Easier to manage positions

Timeline

00:00 ─── 01:00 ─── 02:00 ─── ... ─── 08:00
  │        │        │                  │
  │ Sample │ Sample │ Sample          │
  │ premium│ premium│ premium         │
  │        │        │                  │
  └─ Pay ──┴─ Pay ──┴─ ... ───────────┘
     1/8      1/8
   of rate  of rate

Three Funding Rate Strategies

Backpack supports 3 different calculation strategies:

1. ArithmeticMean (Default)

funding_rate = Clamp(Average Premium, lower_bound, upper_bound)

When used: Most markets - simple, transparent, purely market-driven.

How it works:

Collect premium samples throughout the period
Average them
Clamp to bounds
Done

2. ArithmeticMeanWithInterest

funding_rate = Clamp(Average Premium + Interest Rate, bounds)

When used: Markets where borrowing cost matters.

How it works:

Same as ArithmeticMean
PLUS a base interest rate component
Even if premium = 0, there's a small baseline rate

Why: Mimics traditional futures where there's a "cost of carry" (borrowing cost). Some markets want funding to reflect this.

3. FundingPaymentInterval

funding_rate = (8-hour calculated rate) / (period / interval)

When used: Exchange compatibility.

How it works:

Calculate rate over 8-hour period (like Binance, Deribit)
But pay every hour at 1/8 of the rate
Total over 8 hours = same as one big payment

Why:

Traders can compare rates with other exchanges
But get smoother, more frequent settlements
Best of both worlds

Strategy Comparison

Strategy	Complexity	Use Case
ArithmeticMean	Simple	Pure market-driven funding
ArithmeticMeanWithInterest	Medium	When cost of capital matters
FundingPaymentInterval	Medium	Compatibility with other exchanges

Step-by-Step Example

Starting Point:

Perp: $105
Spot: $100
Premium: +5%
Market is very bullish

Hour 1:

Funding: +0.75% (capped at 1%)
Longs pay $750 per $100k position
Some longs: "This is expensive" → Close (SELL)
Perp drops to $104

Hour 2:

Funding: +0.75%
Arbitrageurs see opportunity
Short perp + buy spot
More SELLING pressure
Perp drops to $103

Hour 3:

Premium now +3%
Funding: +0.5%
Less painful but still costly
Perp drops to $102

Hours 4-8:

Gradual convergence:
- Expensive longs close
- New shorts open
- Arbitrageurs profit

Hour 8:

Perp: $100.20
Spot: $100
Premium: +0.2%
Funding: +0.2%
Near equilibrium ✓

Impact on Trading Decisions

When to Care About Funding

Holding Period	Funding Impact	Consideration
Minutes/hours	Minimal	Usually cross 0-1 intervals
Days	Moderate	Factor into position sizing
Weeks/months	Significant	Can erode profits substantially

Funding as a Trading Signal

High Positive Funding	High Negative Funding
Market very bullish	Market very bearish
Crowded long trade	Crowded short trade
Expensive to be long	Expensive to be short
Contrarian signal?	Contrarian signal?

Basis Trading (Cash-and-Carry Arbitrage)

What Is a Basis Trade?

Basis = Perp Price - Spot Price

When perp trades above spot (positive basis), you can capture this spread:

Perp: $105
Spot: $100
Basis: +$5 (+5%)

Basis Trade:
1. SHORT perp at $105
2. BUY spot at $100
3. Collect positive funding (shorts receive)
4. Wait for basis to shrink
5. Close both positions for profit

This is also called cash-and-carry arbitrage:

Cash = Buy the spot asset
Carry = Hold it while short futures

Why It Works

Your position is delta neutral - no directional exposure:

If BTC goes to $110:
  Spot position: +$10 profit
  Perp short: -$10 loss
  Net: $0 (delta neutral)

If BTC goes to $90:
  Spot position: -$10 loss
  Perp short: +$10 profit
  Net: $0 (delta neutral)

You profit from:
  1. Basis convergence (perp → spot)
  2. Funding payments (shorts receive when positive)

Example P&L

Entry:
  SHORT 1 BTC perp @ $105,000
  BUY 1 BTC spot @ $100,000
  Capital required: $100,000 (for spot) + margin for short

Over 30 days:
  Funding rate: +0.01% per 8hr (typical)
  Funding received: 0.01% × $105,000 × 90 intervals = ~$945

At close (basis converged to +1%):
  Perp now: $101,000
  Spot now: $100,000

  Close SHORT perp: $105,000 - $101,000 = $4,000 profit
  Sell SPOT: $100,000 - $100,000 = $0

Total profit:
  Basis capture: $4,000
  Funding received: $945
  Total: $4,945 on $100,000 = 4.9% monthly return

Contango vs Backwardation

These are fancy words for a simple concept:

Term	Meaning	Plain English
Contango	Perp > Spot	People pay a premium to go long (bullish)
Backwardation	Perp < Spot	People pay a premium to go short (bearish)

Memory trick:

Contango = Futures Continuing higher (premium)
Backwardation = Futures Backing down (discount)

Contango (bull market):          Backwardation (bear market):
  Perp:  $102,000                  Perp:  $97,000
  Spot:  $100,000                  Spot:  $100,000
  Basis: +2%                       Basis: -3%

  Basis trade: WORKS ✓             Basis trade: FAILS ✗

When Does Basis Trading Work?

Market Condition	Basis	Funding	Basis Trade
Contango (bullish)	Positive (perp > spot)	Positive	Works ✓
Backwardation (bearish)	Negative (perp < spot)	Negative	Doesn't work ✗

Historical pattern:

2017: Bull → Contango → Basis trade works
2018: Bear → Backwardation → Basis trade fails
2020-2021: Bull → Contango → Works great
2022: Bear → Backwardation → Fails
2023-2024: Mixed → Sometimes works

Even in a long-term bull market, there are 1-2 year bear periods where basis trading loses.

Basis Trading vs Just Holding

Critical insight: Basis trading is DELTA NEUTRAL - you don't capture price appreciation.

You believe: BTC will 10x over 10 years

Option A - Just Hold:
  Buy 1 BTC at $100k
  BTC goes to $1M
  Profit: +$900k (900%)

Option B - Basis Trade:
  SHORT 1 BTC perp + LONG 1 BTC spot
  BTC goes to $1M
  Spot: +$900k
  Short: -$900k
  Net from price: $0 ← You missed the entire rally!
  Only made: Funding + basis (~15% APY)

Basis Trade: Cost/Benefit Summary

BENEFITS:

Benefit	Description
Delta neutral	No directional risk (price can go either way)
Predictable income	Funding payments are steady in contango
Lower volatility	Returns don't swing with BTC price
Works in sideways markets	Don't need price to move, just need positive basis
Compounds well	Can reinvest funding payments

COSTS:

Cost	Description
Miss the upside	If BTC moons, you don't benefit
Fails in bear markets	Backwardation = losing trade
Capital intensive	Need to buy and hold spot
Execution costs	Fees to enter/exit both legs
Liquidation risk	Short can get liquidated if price spikes
Opportunity cost	Capital locked, can't use elsewhere
Timing required	Need to exit before backwardation

WHO SHOULD USE IT:

Use Basis Trading If...	Don't Use If...
You want steady income	You're bullish and want upside
You're market-neutral	You think BTC will 10x
You already hold BTC and want yield	You have limited capital
You're a professional market maker	You can't monitor positions
You understand the risks	You don't understand liquidation

SIMPLE DECISION FRAMEWORK:

Are you bullish long-term on BTC?
  │
  ├─ YES → Just hold BTC (capture the upside)
  │         Maybe use 20-30% for basis trades
  │
  └─ NO/NEUTRAL → Basis trading can work
                   But exit during bear markets

When to Close

You don't have to wait for perp = spot. Close when:

Trigger	Action
Basis shrinks to target profit	Close for gain
Funding turns negative	Close before paying
Market turns bearish	Close before basis inverts
Better opportunity	Redeploy capital

Example timing:

Entry: Basis = +5%
Target: Basis = +1%

Close when basis hits +1%
Capture 4% basis + funding collected
Don't wait for 0%

Can You Do This Repeatedly?

Yes, but with caveats:

Advantage	Challenge
Works whenever basis is positive	Basis isn't always positive
Delta neutral (low risk)	Capital intensive
Predictable funding income	Liquidation risk on short if price spikes
Repeatable strategy	Execution costs eat into profits

Realistic expectations:

Bull market (basis positive): 10-30% APY possible
Bear market (basis negative): Strategy doesn't work
Mixed market: 5-15% APY if timed well

Pro Tips

1. Entry timing:

Good entry: Basis > 3%, Funding > 0.03% per 8hr
Okay entry: Basis > 1%, Funding > 0.01% per 8hr
Bad entry: Basis < 1% or Funding < 0.01%

2. Exit timing:

Take profit: Basis shrinks by 50%+
Cut loss: Funding turns negative
Reassess: Basis < 0.5%

3. Risk management:

- Don't use max leverage on short (leave buffer for spikes)
- Keep some capital in reserve
- Watch funding rate trend, not just current rate

Technical Implementation

Data Flow

┌─────────────────────────────────────────────────────────────┐
│                 Continuous (every few seconds):              │
│                                                              │
│    Mark Price ──┐                                           │
│                 ├──→ Premium = (Mark - Index) / Index       │
│    Index Price ─┘              │                            │
│                                ↓                            │
│                   Add to interval_funding_rate_sum          │
│                   Increment sample_count                    │
└─────────────────────────────────────────────────────────────┘

┌─────────────────────────────────────────────────────────────┐
│                 At interval end (funding crank):            │
│                                                              │
│    1. average = sum / sample_count                          │
│    2. funding_rate = Clamp(average, lower, upper)           │
│    3. For each position:                                    │
│       payment = |rate| × |quantity| × mark_price            │
│       if long and rate > 0: pay                             │
│       if short and rate > 0: receive                        │
│    4. Reset accumulators                                    │
│    5. Emit FundingRateUpdatedEvent                          │
└─────────────────────────────────────────────────────────────┘

Ledger Balancing

Funding is zero-sum - money moves between traders, not in/out of system:

Total paid by longs = Total received by shorts
(with tiny rounding adjustment)

Storage

Storage	What	Purpose
Engine (in-memory)	Current interval data	Real-time calculation
PostgreSQL	Market configuration, bounds	Settings
ClickHouse	Historical rates & payments	Analytics, audit

Key Files

Component	Location
Funding rate models	`/engine/src/models/funding_rate.rs`
Payment processing	`/engine/src/engine/funding_rate.rs`
Strategy definitions	`/core/types/src/models/order_book.rs`
Bounds configuration	`/core/types/src/models/order_book.rs`
Funding crank	`/cronjobs/src/funding.rs`
Market creation (CLI)	`/cli/src/market.rs`
ClickHouse models	`/clickstore/core/src/models/funding_rate.rs`

Summary

Question	Answer
What is funding rate?	Periodic payment to align perp with spot
Who pays?	Side pushing price away from spot
How much?	Typically 0.001% - 0.01% per 8hr
How often?	Hourly payments (configurable)
Is it capped?	Yes, ±1% default (per-market configurable)
Why does it exist?	Economic pressure → closing/opening → price converges
How does closing a long drop price?	Closing LONG = SELLING = price down

Funding Rate - How Perpetual Contracts Stay Aligned with Spot ​

TL;DR ​

Why Funding Rate Exists ​

How Funding Actually Keeps Prices Aligned ​

The Complete Mechanism ​

Three Forces at Work ​

Visual Flow ​

The Core Formula ​

Premium (How Far Perp Is From Spot) ​

Funding Rate ​

Who Pays Whom? ​

Payment Calculation ​

Bounds / Caps ​

Backpack's Default Bounds ​

How Clamping Works ​

Realistic Funding Rate Examples ​

Payment Timing ​

Backpack's Approach ​

How It Works ​

Timeline ​

Three Funding Rate Strategies ​

1. ArithmeticMean (Default) ​

2. ArithmeticMeanWithInterest ​

3. FundingPaymentInterval ​

Strategy Comparison ​

Step-by-Step Example ​

Impact on Trading Decisions ​

When to Care About Funding ​

Funding as a Trading Signal ​

Basis Trading (Cash-and-Carry Arbitrage) ​

What Is a Basis Trade? ​

Why It Works ​

Example P&L ​

Contango vs Backwardation ​

When Does Basis Trading Work? ​

Basis Trading vs Just Holding ​

Basis Trade: Cost/Benefit Summary ​

When to Close ​

Can You Do This Repeatedly? ​

Pro Tips ​

Technical Implementation ​

Data Flow ​

Ledger Balancing ​

Storage ​

Key Files ​

Summary ​

Funding Rate - How Perpetual Contracts Stay Aligned with Spot

TL;DR

Why Funding Rate Exists

How Funding Actually Keeps Prices Aligned

The Complete Mechanism

Three Forces at Work

Visual Flow

The Core Formula

Premium (How Far Perp Is From Spot)

Funding Rate

Who Pays Whom?

Payment Calculation

Bounds / Caps

Backpack's Default Bounds

How Clamping Works

Realistic Funding Rate Examples

Payment Timing

Backpack's Approach

How It Works

Timeline

Three Funding Rate Strategies

1. ArithmeticMean (Default)

2. ArithmeticMeanWithInterest

3. FundingPaymentInterval

Strategy Comparison

Step-by-Step Example

Impact on Trading Decisions

When to Care About Funding

Funding as a Trading Signal

Basis Trading (Cash-and-Carry Arbitrage)

What Is a Basis Trade?

Why It Works

Example P&L

Contango vs Backwardation

When Does Basis Trading Work?

Basis Trading vs Just Holding

Basis Trade: Cost/Benefit Summary

When to Close

Can You Do This Repeatedly?

Pro Tips

Technical Implementation

Data Flow

Ledger Balancing

Storage

Key Files

Summary