My Insights into the Dynamics of Funding Rates
As a trader with several years of experience, I've only recently entered the world of derivatives. It feels a bit uncomfortable to reveal, but just a few months ago, I had little understanding of how Delivery Futures or Options worked, and I was completely unaware of how wildly volatile the Funding Rate on Perpetuals could be.
Why Funding Rates Matter
In perpetual futures, a type of futures contract without an expiry date, the funding rate helps align the prices of perpetual contracts with the underlying asset's spot price. This mechanism involves periodic payments between buyers (long positions) and sellers (short positions), depending on market conditions. When the price of the perpetual contract is higher than the spot price, the buyers pay the sellers. Conversely, when the contract's price is lower, the sellers pay the buyers.
This topic has become increasingly relevant to me for two reasons:
Hedging with Derivatives: Derivatives are excellent tools for hedging. I use them to maintain stability in my portfolio, ensuring it includes only the assets I wish to hold. For instance, I recently needed USDT but only had ETH. The solution was straightforward: sell ETH on the spot market for USDT and open a Long position on Perpetuals, equivalent to the sold ETH amount. This strategy allows me to keep my ETH exposure while freeing up USDT for trading. However, it's important to note that this isn't a cost-free operation due to associated fees and the Funding Rate.
Profit from Funding Rate: Upon investigating the history of Funding Rates, I noticed that they are predominantly positive for most coins. So, I can use the opposite scenario and profit from Short trades. If I have extra USDT, I can, for example, allocate 70% to buy a coin like ETH on the spot market and use the remaining 30% to open a Short position in the same ETH amount. This approach helps me preserve my USDT and earn profits from the Funding Rate. Additionally, investing in a staking coin can yield extra profits. This method also can be viewed as creating a customized stablecoin with minimal or no exposure to USDT.
It's crucial to acknowledge the risks associated with the strategies described above
In this post, I'm focusing on studying Funding Rates. My goal is to understand the potential costs in the first scenario and the possible profits in the second. I found a useful tool on the Coinglass website that shows Accumulated Funding Rates on different exchanges. However, it only provides data for up to one year. This limitation led me to conduct my own research to uncover trends from previous years, covering both bull and bear markets.
Results
I developed a script to extract the funding rates from various exchanges, and then I grouped this data by year to calculate the accumulated totals. The results were intriguing, though most of the historical data starts from 2021. Here, I reveal my findings for the most relevant BTC and ETH markets:
The data clearly shows that during 2020-2021, the Funding Rate was high and volatile, whereas it stabilized and remained relatively low in 2022-2023. I also created a plot that correlates asset prices with accumulated funding rates on a monthly basis, illustrating that periods of high Funding Rates are closely linked with price change.
Key Insights
Two insights emerge from this analysis:
Using 2nd strategy described above can yield profits during a crypto bull run even for USDT holdings, though this strategy requires careful handling, preferably not manual, due to holding a short position in a rising market.
Delivery Futures might be a better hedging option since they don't involve Funding Rates. If you enter a long-term position in Delivery Futures you'll pay a fixed percentage that matches the price deviation from the spot at the time of entry. Currently, on Binance, this rate ranges from approximately 8.5 to 9.5% per year for contracts with durations of 3 and 6 months.
Of course, the data received doesn’t guarantee a repetition of past patterns in the future, and I am very curious to see how Funding Rates will behave in the coming years.
Resources
Thank you for reading. If you're interested in researching other coins or want all the data for your analysis, you can follow the GitHub link provided below.