FTX EXCHANGE (INCLUDING FTX INTERNATIONAL AND FTX.US) ARE NO LONGER IN OPERATION
Both exchanges have filed for bankruptcy. Subsequently, the exchange was “hacked” and more than US$600 million worth of cryptocurrencies drained. The hacker is strongly rumoured to be a former FTX employee. For more about how this story unfolded and the latest news, check out these articles:
- SBF vs CZ War: What’s happening with FTX and Binance?
- Binance to Acquire FTX: What This Means for All Investors
- Binance Will NOT Acquire FTX: What is Next?
- BlockFi suspends withdrawals over unclear status of FTX
- FTX, FTX US and Alameda File for Bankruptcy
- FTX Hacked: Hacker Identity Revealed by Kraken
- What will happen to BlockFi?
- Were BlockFi’s assets held on FTX?
FTX is a cryptocurrency exchange built by traders, for traders. FTX funding rate comes in where long traders “meet” short traders directly under their platform. No more middlemen, no more broker fees.
Background of FTX
FTX is made of an all-star team where every member comes from leading Wall Street firms and technology companies, including Google, Facebook, Jane Street, Optiver and Susquehanna.
The CEO and founder of FTX, Sam Bankman-Fried was a trader on Jane Street Capital’s international ETF desk before he founded one of the best cryptocurrency trading platforms in the market. He decided to build FTX in the midst of searching for a cryptocurrency trading place where it comes from a trader’s perspective. When he found none, he made the bold move to start his own crypto company; hence, their slogan is “Built by Traders, For Traders”.
FTX was created to fulfill every trader’s needs, no matter where you stand. Be it for the professional, experienced traders who watch the crypto market 24/7, or the beginner who wants to try to get their feet wet in the crypto trading market, FTX provides user-friendly and comprehensive features and explanations in their one-stop system.
What problem is the FTX Funding Rate trying to solve?
First, we have to know the difference between Traditional Futures and Perpetual Futures.
The expiration date is the fundamental aspect of Traditional Futures contracts. When a contract ends, the settlement procedure begins. Traditional Futures contracts usually settle once a month or once a quarter. During the settlement period, the contract price converges with the spot price and then all open positions will expire.
Crypto-derivative exchanges like FTX often provide Perpetual Futures contracts, which are structured similarly to Traditional Futures contracts. Perpetual contracts, on the other hand, have a significant advantage.
Traders in Perpetual Futures can stay in the position without an expiration date and do not need to keep track of different delivery months, unlike Traditional Futures. A trader, for example, can keep a short position open indefinitely unless it is liquidated.
Simply speaking, Traditional Futures is a contract that has an expiry date whereas Perpetual Futures do not expire. Furthermore, Traditional futures usually have a broker in between the trading process where he/she will ask you to top up the amount accordingly based on the “margin calls” or margin difference between the contract price and the spot price. Perpetual Futures are handled by you and only you as the trader.
Due to the fact that perpetual futures contracts never settle in the conventional sense, the exchanges require a system to ensure that futures and index prices converge on a regular basis. There’s where the funding rate kicks in.
What is a Funding Rate?
Funding rates are periodic payments to long traders, which foresee the market will go up, and short traders, which foresee the market will go down, based on the difference between the perpetual contract market and spot prices.
Hence, depending on where your standpoint is, you either will receive payment or you are the one paying it.
When the funding rate is positive, the perpetual contract’s price is greater than the mark price. This is where the long traders pay for short traders. On the other hand, when the funding rate is negative, it shows that perpetual prices are below the mark price where the short traders pay for long traders.
The image below shows a few of the funding rates from different cryptocurrencies on the FTX website on 16 June 2021 at 1pm.
Why do Funding Rates Exist?
Futures contracts expire at a future date i.e. the “settlement date” and when this happens, the futures price will meet with the current spot price at the time. That is, the futures price is a predetermined spot price at a future date.
The futures market can be in one of two states relative to the spot price:
- Contango: The futures market is trading at a premium (i.e. above the spot price); or
- Backwardation: The futures market is trading at a discount (i.e. below the spot price).
The difference between the futures market and the spot market is referred to as the “basis”.
Meanwhile, perpetual contracts do not expire, but they still need to settle at a spot price. However, there are sometimes differences between the spot price and the futures price on a cryptocurrency exchange. This is despite the fact that they should be in line since they need to settle against each other over time.
Therefore, to keep the spot price and the contracts prices in line, exchanges add an interest rate component (i.e. a funding rate). This funding rate incentivizes traders to take positions which help close the gap between these prices, whilst penalizing those that do the opposite. Basically:
- When the funding rate is positive, those who are long pay those who are short. This means those who are short will benefit and consequently, people are incentivized to take short positions; and
- When the funding rate is negative, those who are short pay those who are long. So if you are in a long position, you will receive the funding paid by those who are short.
Traders avoid paying the “penalty” by closing their long or short positions (as the case may be) before the funding rate expires. When traders do this, the prices between the contracts and spot prices will begin to converge.
For example, when the contracts price is above the spot price, the funding rate is positive. In such cases, those who are long pay those who are short. Traders with long positions are encouraged to close their positions before the funding rate expires to avoid paying. Meanwhile, traders are incentivized to open short positions because they can receive payment. The effect of this is that the contracts price will be pushed down and the gap between that and the spot price will be closed.
On the other hand, when the contracts price is below the spot price, the funding rate is negative. Shorts will pay the longs. Therefore, traders with short positions will try and close their positions to avoid payment and open long positions to receive payment. Thus, the contracts price will be pushed up to meet the spot price.
How FTX Funding Rates Work
Crypto funding rates prevent lasting divergence in the price of both markets. FTX recalculates the funding rate every hour, 24 times a day.
Whereas quarterly futures expire, perpetual futures have funding payments every hour. Specifically, every hour, FTX measures the 1-hour TWAP of the perpetual future and the 1-hour TWAP of the underlying index:
This is similar to the future expiring once per day. In particular, if you sell a BTC perpetual future that is trading 0.10% above the underlying index all day, then over the course of the next day you will receive a total funding payment of 0.10%.
For example:
You’d like to buy $100,000 for Bitcoin. Then, according to the predicted funding rate shown in the image above at that moment, you would pay the short traders $0.90 on that particular hour to directly promote the one who has short exchange.
100,000* (0.0009%)= $0.90
This funding rate is a very direct and powerful tool to promote the other side of the trading exchange when either the position is at a positive or negative point. In this example, the market needs to balance off the bullish market by promoting the bearish investors.
Funding rates are done on a peer-to-peer basis. Therefore, FTX does not charge any fees from funding rates as they happen directly between traders – by traders, for traders.
In short, funding payments on FTX are hourly payments exchanged between longs and shorts on perpetual futures.
How to make money and earn passive income from FTX Funding Rates
One tip to make some “passive income” from FTX funding rates is to buy AND short the exact same amount of the cryptocurrency you put your money on.
This method can balance out the positive and negative funding rates, where technically you do not have the position in that particular cryptocurrency market since it is counterbalanced.
However, your short trading will get paid on an hourly basis. So, you can get some great “passive money” on the side, even though overall it mostly turns out to be net value since you have the positive trades too.
This defunding method is a lot of big trading firms’ favorite method to get quick money in a larger amount.
Conclusion
In the Perpetual Futures market, crypto funding rates are crucial. Most crypto-derivatives exchanges like FTX use a funding rate method to ensure that contract prices are always in line with the index. Market factors dictate these rates, which fluctuate when asset values change bullish or bearish.
Take the advice here with a pinch of salt as every fluctuation in the market is unpredictable and risky.
Check out our other FTX guides
- FTX exchange guide– Step by step guide on how to get started with FTX.
- FTX exchange review– Our review of FTX exchange.
- FTX funding rates– Learn how to earn passive income on FTX with funding rates.
- Crypto futures trading with FTX– Guide to crypto futures trading on FTX.
- Derivatives trading with FTX– Guide to derivatives trading on FTX.
Disclaimer: Cryptocurrency trading involves significant risks and may result in the loss of your capital. You should carefully consider whether trading cryptocurrencies is right for you in light of your financial condition and ability to bear financial risks. Cryptocurrency prices are highly volatile and can fluctuate widely in a short period of time. As such, trading cryptocurrencies may not be suitable for everyone. Additionally, storing cryptocurrencies on a centralized exchange carries inherent risks, including the potential for loss due to hacking, exchange collapse, or other security breaches. We strongly advise that you seek independent professional advice before engaging in any cryptocurrency trading activities and carefully consider the security measures in place when choosing or storing your cryptocurrencies on a cryptocurrency exchange.
