Guide: Funding Rate, Margin and Liquidations in Perps

Futures

A traditional future is an agreement to purchase an asset, such as gold (or Bitcoin) at a set point in the future, for a fixed price.

If you’ve ever been rekt by leverage, you’ll likely have met the perpetual future, or perp for short.

The reason perps are so popular is unlike traditional futures, they don’t have a settlement date (they are perpetual) and are cash settled, rather than requiring physical delivery of the asset.

This makes them much easier to trade. Combine that with the ability to leverage positions (for example, take out a $1,000 notional position with only $100 (10x leverage), and get all gains, or losses, from that $1,000 notional), and the ease of shorting an asset, and it’s easy to see why perps have exploded in crypto markets.

Perps are an example of ingenious crypto innovation, treading where no one had before. They didn’t exist until 2016, when they were first launched by Bitmex, and are now a sort of poster child for crypto.

At the time of writing, mid-March 2022, the 24-hour trading volume of perps was $153 billion.

• For more information on futures in crypto, especially in DeFi, check out our research report, Leaping into the Futures.
• To find out about our top picks, including target valuations, technical analysis and more, see our DeFi derivatives series conclusion, The $1 Quadrillion Bet.

Margin and Liquidations

If you’ve only put in $10, but you have exposure to $1,000 of the asset, that means that a mere 1% move would wipe you out.

To make futures trading possible, and to ensure exchanges don’t get stung if there’s a sudden 5% drop (meaning the money in the account wouldn’t cover the loss of the position), they use margins and liquidations.

This can get complex, but simply put:

Margin: what makes it possible to trade with leverage. The margin is the collateral you have in your futures account. This prevents exchanges from having to pay for your losses if there is a 5% drop suddenly, as it means there is capital in your account to pay for the loss.

Liquidation: if you fall below the minimum margin required, your position or positions will be liquidated, meaning you lose everything. Another mechanism to prevent losses you can’t pay for.

Exchanges display your liquidation prices, margin level and requirement, among other information on their pages. See the below example from Binance:

Due to the level of leverage and volatility of the crypto markets, liquidations are far too regular.

You may have heard of markets dropping due to cascading liquidations. This refers to people positions being liquidated, which increases sell pressure, driving the price down, resulting in more liquidations… it’s a vicious cycle.

Always be cautious when trading perps, never risk what you can’t lose, and keep leverage low!

Funding Rate

The funding rate is used to keep the perp in line with the underlying asset, involving regular payments between buyers and sellers (often every 8 hours, although it can vary, with dYdX and Perpetual Protocol conducting payments every hour).

If the price of the perp is greater than the underlying, the funding rate is positive, meaning traders who are long (buyers) have to pay those who are short. This disincentivises buying and incentivises selling, bringing down the price to fall in line with the underlying.

Essentially, if the sentiment is bullish, this incentives people to close longs and take out shorts, bringing the price down, back in line with the asset.

If the funding rate is negative, shorts pay longs, incentivising buying and disincentivising selling, raising the perp price to fall in line with the underlying.

Generally, funding falls between 0.025% and -0.025%. At times of extreme volatility this can increase dramatically, having reached 0.14% on 21st Oct 2021.

It is important to note that the funding rate is charged against your notional position, so if you put down $10 using 100x leverage, you will be charged a percentage of the $1,000 notional position.

The funding rate is calculated across the exchange, and applies to all long/short positions in the same way.