What is the Funding Rate? | Explaining the Core Mechanism of Derivative Trading

Funding Rate refers to the periodic payments exchanged between long (buy) and short (sell) position holders when trading perpetual contracts (perpetual futures) on derivative exchanges like Bybit. This mechanism functions as a market adjustment tool to prevent overheating and is calculated based on the trader’s position value.

Real-Time Fluctuations and Time Structure of the Funding Rate

When accessing the derivatives trading page, you can observe the funding rate fluctuating in real time. These fluctuations are always progressing toward the next funding timestamp.

Bybit sets multiple funding intervals, with the most common example being an 8-hour cycle:

1. From 00:00 UTC to 08:00 UTC

   • The funding rate is calculated during this 8-hour period and settled exactly at 08:00 UTC.
   • At this point, whether long positions receive funding from shorts or pay shorts is finalized.

2. From 08:00 UTC to 16:00 UTC

   • The same logic applies, with the second funding occurring at 16:00 UTC.

This 8-hour cycle results in three settlement points per day, and traders periodically either receive or pay funding fees.

How the Funding Rate is Calculated: Two Layers — Interest Rate and Premium Index

To understand how the funding rate is derived, it’s essential to know its components. The funding rate is primarily determined by two factors:

Role of the Interest Rate (I)

The interest rate (I) is a fixed baseline rate for the funding mechanism. For example, in BTCUSD, the interest rate is fixed at 0.03% per day. For an 8-hour funding interval, this rate is divided by 3, resulting in 0.01% per period.

The formula is:

Interest Rate (I) = 0.03% ÷ (24 ÷ Funding Interval Hours)

In some pairs like USDCUSDT or ETHBTCUSDT, the interest rate is set to 0% by default. In these markets, the premium index plays a more significant role.

Market Balance Adjustment via Premium Index (P)

Perpetual contracts can trade at a premium or discount relative to the standard mark price. The premium index captures this deviation and adjusts the next funding rate accordingly.

Premium Index (P) = [Max(0, Impact Buy Price − Index Price) − Max(0, Index Price − Impact Sell Price)] ÷ Index Price

A key concept here is the Impact Margin Notional, which indicates the volume that can be traded at a certain margin. It measures the depth of the order book and helps assess how much the market can withstand in terms of orders.

The average premium index (P) is calculated as a weighted average of the premium index values from the previous settlement period to the current time. For an 8-hour cycle, data points over 480 minutes are weighted by elapsed time:

Average Premium Index (P) = (Premium Index₁ × 1 + Premium Index₂ × 2 + … + Premium Index₄₈₀ × 480) ÷ (1 + 2 + … + 480)

Since data closer to the settlement time has a larger coefficient, this design emphasizes the most recent market conditions.

Final Funding Rate Formula and Limits

The interest rate and premium index, processed through Bybit’s per-minute weighted average price (TWAP), are combined as follows:

Funding Rate (F) = Clamp[Average Premium Index (P) + Clamp(Interest Rate (I) − Average Premium Index (P), 0.05%, −0.05%)], Funding Rate Cap, Funding Rate Floor]

The Clamp function restricts the value within specified upper and lower bounds.

Role of Funding Rate Caps

In volatile markets, the perpetual contract price can deviate significantly from fair value. To prevent this, Bybit can flexibly adjust the upper and lower limits of the funding rate.

Under normal, stable market conditions, the rules are:

• Funding Rate Cap (Upper Limit) = min[(Initial Margin Rate − Maintenance Margin Rate) × 0.75, Maintenance Margin Rate]
• Funding Rate Floor (Lower Limit) = −min[(Initial Margin Rate − Maintenance Margin Rate) × 0.75, Maintenance Margin Rate]

Where IMR (Initial Margin Rate) and MMR (Maintenance Margin Rate) represent the minimum risk thresholds for each symbol.

In cases where the futures and spot markets diverge sharply, the coefficient 0.75 may be adjusted within a range of 0.5 to 1 to strengthen the adjustment mechanism.

Special Rules for Funding Rate in Pre-Market Perpetual Contracts

When listing new instruments, Bybit’s pre-market perpetual contracts use a different funding rate calculation logic, depending on the market’s maturity:

During Call Auction Period

• The funding rate is fixed at exactly 0.
• Neither the premium index nor interest rate participate in funding fee calculations.
• The environment is focused solely on price discovery.

After the Continuous Auction Period

• The funding rate is raised to a fixed rate of 0.005%.
• Funding exchanges occur periodically every 4 hours.

This phased approach helps stabilize new markets while maintaining harmony with existing markets.

Funding rate is not just a fee; it reflects market supply and demand dynamics, aligning perpetual contract prices closer to spot markets. Understanding the interaction between interest rate and premium index allows traders to better grasp the actual cost of holding positions.