Mechanism and Calculation Method of Funding Rates in the Derivatives Market

In perpetual futures trading, the funding rate mechanism plays a crucial role in maintaining market stability. The funding rate reflects the supply and demand balance on the exchange or market and directly impacts traders’ position management. Here, we will explain the basics of the funding rate and its calculation mechanism step by step.

What Is the Funding Rate — Basic Mechanism

The funding rate visible on the derivatives trading page fluctuates in real-time until the next funding timestamp. Because it dynamically reflects the current market conditions, its value changes over time.

For example, consider an 8-hour funding interval. The funding rate calculated between 12:00 a.m. (UTC) and 8:00 a.m. (UTC) is settled at 8:00 a.m. Similarly, rates calculated from 8:00 a.m. to 4:00 p.m. are settled at 4:00 p.m. This cycle ensures that funding payments are periodically settled throughout the 24-hour period.

Components of the Funding Rate — Interest and Premium Index

The funding rate is not a single indicator but composed of two elements: Interest (I) and Average Premium Index (P). These combine to determine the funding fee that accurately reflects market conditions.

In the calculation process, a weighted average price over N hours (TWAP) is used to compute the interest and premium index on a per-minute basis. As the settlement time approaches, the coefficient for the premium index increases, better reflecting the market’s most volatile periods.

The calculated funding rate is applied to the trader’s position value, determining the amount paid or received at the funding exchange time.

Funding Rate Calculation Logic — Understanding with Examples

Funding Rate Formula

The funding rate (F) is calculated as follows:

Funding Rate (F) = Clamp [ (P + Clamp (I − P, 0.05%, −0.05%) ), upper limit, lower limit ]

While this formula may look complex at first glance, breaking it down element by element makes it easier to understand.

First Element: Interest (I) Calculation

Interest is a fixed benchmark element for the overall market:

Interest (I) = 0.03% / (24 / Funding Interval Hours)

For BTCUSD, the interest rate is fixed at 0.03% per day. For an 8-hour funding interval, this results in 0.01% per interval.

Note that for certain trading pairs like USDCUSDT, ETHBTCUSDT, the interest rate (I) is set to 0% by default.

Second Element: Role of the Premium Index (P)

When perpetual contracts trade at a premium or discount relative to the mark price, the premium index adjusts for this deviation to balance the contract trading level. It influences the next funding rate by raising or lowering it to maintain equilibrium.

Premium Index (P) Calculation:

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

Key prices involved:

• Impact Bid Price: The average price needed for the bid side to execute Impact Margin Notional.
• Impact Ask Price: The average price needed for the ask side to execute Impact Margin Notional.

Impact Margin Notional is a conceptual amount that can be traded with a certain margin, used to gauge order book depth and measure impact bid or ask prices. This value is denominated in USDT and can be checked on the exchange’s official page.

Weighted Calculation of the Average Premium Index (P)

To improve accuracy, the average premium index is calculated via a weighted average algorithm, incorporating the premium index values from the previous settlement period to the current time. This approach produces a stable indicator that does not overreact to short-term market fluctuations.

For an 8-hour funding interval, the formula is:

Average Premium Index (P) = (P₁×1 + P₂×2 + … + Pₙ×n) / (1 + 2 + … + n)

where each Pₙ is the premium index at a specific time. This method ensures that more recent premium index values have a greater influence, reflecting current market conditions more accurately.

Adjustment Mechanism During Market Volatility

In periods of high market volatility, the upper and lower limits of the funding rate may be temporarily adjusted to encourage the perpetual contract price to revert to a reasonable range.

Typically, the limits are set as:

• Funding Rate Upper Limit = min[(Initial Margin Rate − Maintenance Margin Rate) × 0.75, Maintenance Margin Rate]
• Funding Rate Lower Limit = −min[(Initial Margin Rate − Maintenance Margin Rate) × 0.75, Maintenance Margin Rate]

IMR (Initial Margin Rate) and MMR (Maintenance Margin Rate) represent the minimum risk thresholds for each symbol.

Note that if a significant price gap occurs between the futures and spot markets, the coefficient 0.75 may be dynamically adjusted within the range of 0.5 to 1.0. This allows the system to respond appropriately to extreme market dislocations. Always check the official page for the latest funding limit settings.

Special Funding Rate for Pre-Market Perpetual Contracts

Pre-market perpetual contracts use a different funding rate calculation due to their incomplete maturity stage.

There are two scenarios:

Scenario 1: During Call Auction Period

During this period, the funding rate is fixed at zero. The premium index and interest do not participate in funding fee calculations, so traders do not pay funding fees. This temporary freeze helps stabilize price discovery during market formation.

Scenario 2: During Continuous Auction Period

In this phase, the funding rate is fixed at 0.005% and settled every 4 hours. The lower funding fee reflects the pre-market stage, gradually transitioning to the standard funding rate calculation as the contract matures.

Understanding these mechanisms allows traders to manage their positions more effectively by anticipating funding fee movements based on market conditions.