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If you are abreast of crypto educational news, then you must have come across various important terms that have some correlation with the cryptocurrency. One such is the Funding rate. You will find this new concept in perpetual futures contracts. In short, the funding rate is a small fee paid by one section of the contract to the other. It varies from short or long pay. The prime motive is to push the price of the perpetual futures contract to remain near the basic spot index price. Let us help you understand more about it in this article.
Concept Of Funding Rate
The funding rate is closely related to digital assets. In other words, it is a mechanism that defines the correspondence between index and contract prices. This term can also be defined as periodic payments that are either short or long based upon the difference between spot prices and persistent contract markets. Hence, it depends upon the situation, on whether the trader will make the payment or will they receive funding. During the time of high volatility, there is a difference in the price of the lasting trade at the time of low volatility, resulting in maximum funding rate to minimize or fence the gap between the spot price and perpetual swap.
Use Of Funding Rate During Crypto Trading
The funding rate represents a sign of the volatility of the underlying asset, different from what has been said before. While exploring this term, you will notice that there is a close link between the movement of funding rate and the spot price. We mean to say that, whenever there is more movement in the spot price, it simultaneously leads to an increase in funding rate and vice versa. But here you need to understand that the funding rate is always led by the price, not the other way round.
Also note that if the funding rate is higher, then there will be a large division between the spot price and lasting trade. It shows the investors higher interest in selling and buying of basic crypto. Although a volume increase also determines the indication of the robust interest of investors, it can be manipulated, as described by many studies.
So, here you find that the funding rate does determine real interest in selling and buying of a digital asset. The more positive the funding rate is, the more it will indicate interest in buying. Contrary to it, if it shows the negative, then it will certainly indicate the pressure of selling. A case in mid-March 2020 is the best example to mention. Now, look at another approach. If in case there is a declining funding rate from the highs, then it defines the investors’ minimal interest. However, it will be wrong to assume the reversing situation of the basic asset price.
Impact On Traders
Now, if you ask about what impact do funding rate has on traders, then there is a valid and simple theory to answer it. Funding rate can help in the development of trading strategies by the traders, and can even lead to profits amid markets with low volatility. Moreover, funding rates are designed to influence traders to take a stand in bringing spot market and perpetual contract prices together.
Conclusion
So this is all about the funding rate, which is being explained in this article. Today, you get to know all about the important facts about it. If you are abreast of cryptocurrency latest news today, then you must have noticed how many cryptocurrency exchanges refer to funding rate tool to line up the index with contract prices, most of the time. However, the rates can vary at times when asset prices revolve to bearish or bullish phase, defined by market forces. One important fact you need to know about is that funding rates might also reflect differences through exchanges. The rates can be continuously higher on certain exchanges. Taking an example of Binance Futures, where a lower funding rate is maintained.
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