Funding Costs

This article focuses on the definition of funding costs, funding rates, components of funding rates, calculation and other related issues.

Preface

As we know, before the expiration of a futures contract, its price may deviate from the spot price; the difference between these prices is called the "basis spread". As a futures contract approaches its expiration date, the basis spread will gradually approach zero.

Since perpetual contracts have no settlement or expiration dates, how do they narrow the spread and keep their latest market price anchored to the spot price? This is possible due to the use of the funding fee mechanism.

Definition of funding fee

The funding fee is the main mechanism by which MEME ensures that the latest market price remains anchored to the global spot price, somewhat similar to the SWAP on a position held in a spot margin trade.

How the funding fee is paid or collected

The funding rate is charged every 8 hours for one period, and is settled at the end of each period. That is, 00:00-08:00 for one period, the settlement time is 08:00; 08:00-16:00 for one period, the settlement time is 16:00; 16:00-the next day 00:00 for one period, the settlement time is 00:00. All the above times are subject to UTC+8 time. If the funding rate is positive, the long position will pay the funding fee to the short position. Conversely, if the funding rate is negative, the short position will pay the funding fee to the long position. Traders are only required to pay or receive a funding fee for positions held at these time cutoffs. If a trader closes a position before the specified funding fee timestamp, no funding fee is paid/received.

What is the funding fee rate

Funding Fee = Position Value * Funding Fee Rate.

Before we can understand how the funding fee makes the latest market price always anchored to the spot price, we need to understand the key element of the funding fee, the composition of the funding rate. The funding rate is divided into two main components, the interest rate and the premium index.

1.Interest rate: The base currency and the denominated currency are included.

For example, the base currency of the BTC/USD perpetual contract is BTC and the denominated currency is USD, in other words, the interest rate is a function of the interest rate between these two currencies: Interest Rate (I) = (Denominated Rate Index - Base Rate Index) / Funding Rate Time Interval.

Of which:

Prime rate index = borrowing rate in the base currency

Denominated rate index = borrowing rate in the denominated currency

Time interval of funding rates = 8

2.Premium index = ( Max ( 0 , depth-weighted bid price - marker price) - Max ( 0 , marker price - depth-weighted ask price)) / spot price + reasonable base rate of marker price

Calculation of the funding rate

The funding rate is calculated based on the interest rate and the premium/discount component of the funding rate interval for each contract, with a buffer zone of +/- 0.025% set by MEME.

Funding rate = premium index + clamp (interest rate - premium index, 0.025%, -0.025%)

So, when (Rate - Premium Index) is between +/- 0.025%, the funding rate = Premium Index + (Rate - Premium Index) = Interest Rate.

In other words, the funding rate will be equal to the interest rate. This calculated funding rate will be used to calculate the value of the trader's position and then to calculate the funding fee to be paid or charged at the corresponding time stamp.

*The funding fee is charged by the long and short sides to each other, the MEME platform does not receive funding fees.