Funding Rates in Crypto Perpetual Futures and Their Redistribution

Funding rates are a key mechanism in crypto perpetual futures that help tether the derivative’s price to its underlying spot market. In our protocol, the funding rates collected from hedged positions are not only used to maintain price parity but are also redistributed to holders of staked liUSD—providing an additional yield stream for participants.

What Are Funding Rates?

• Purpose:
  
  Funding rates are periodic payments exchanged between traders holding long and short positions. Their main goal is to keep the perpetual futures price in line with the spot price of the underlying asset.

• Mechanism:
  
  Unlike traditional futures contracts, perpetual futures do not have an expiry date. Instead, exchanges use funding rates to simulate the cost-of-carry. When the futures price deviates from the spot price, the funding rate adjusts to incentivize market participants to bring the two prices back into alignment.

How Funding Rates Are Paid

• Payment Cycle:
  
  Funding payments are typically calculated and settled at regular intervals (often every 8 hours).

• Direction of Payment:

  • Positive Funding Rate:
    
    When the perpetual futures price is above the spot price, traders holding long positions pay a fee to those holding short positions.
  • Negative Funding Rate:
    
    Conversely, if the futures price is below the spot price, short position holders pay longs.

• Automatic Settlement:
  
  The exchange automatically calculates the rate based on the price divergence and transfers funds between accounts accordingly, ensuring that the net funding across the market is balanced.

Redistribution to Staked liUSD Holders

In our protocol, the funding rate mechanism is integrated with a yield distribution model that benefits stakers:

• Collection:
  
  Funding payments collected from hedged positions are pooled within the protocol. This reserve accumulates funding rate income from active trading positions.

• Redistribution:
  
  A portion of the accumulated funding is periodically redistributed to users who have staked their liUSD tokens. This mechanism rewards stakers by sharing the income generated from market funding rates.

• Mechanism Details:

  • Staking Rewards:
    
    Stakers receive rewards proportional to the amount of liUSD they have locked in the protocol and the duration of their stake.
  • Automated Process:
    
    Smart contracts handle the calculation and distribution automatically, ensuring transparency and efficiency.
  • Incentive Alignment:
    
    By redistributing funding income, the protocol not only stabilizes the market through effective hedging but also incentivizes users to stake liUSD, thus enhancing overall liquidity and security.

Some Typical Numbers

• Variability:
  
  Funding rates can vary over time, reflecting market sentiment and volatility.

• Examples:

  • For assets like Bitcoin, funding rates might typically range from around -0.05% to +0.05% per funding interval, but can spike higher during periods of extreme volatility.
  • Similar ranges apply to other major assets such as Ethereum.

• Accumulated Yield:
  
  Although the individual funding payments may be small, over multiple intervals these amounts can add up, providing a meaningful yield for stakers.

How Funding Rates Were Created

• Origin:
  
  The concept was developed by crypto exchanges to address the challenge posed by non-expiring perpetual contracts. Traditional futures rely on rollovers, whereas perpetual futures require a mechanism to simulate the cost-of-carry.

• Evolution:
  
  After various experiments, funding rates emerged as the most effective tool to incentivize traders to converge the futures price with the spot price. Today, they are a standard feature across major crypto derivatives platforms.

Summary

Funding rates in crypto perpetual futures serve to align the futures price with the spot market and generate a recurring income stream. In our protocol, a portion of these collected funding payments is redistributed to holders of staked liUSD, providing them with additional yield. This approach not only helps maintain market stability but also rewards participants for supporting the ecosystem through staking.