Bitmex perpetual swap and funding rate

Many cryptocurrency traders trade on Bitmex. It’s one of the most advanced trading platforms. The most professional prominent traders mostly trade on Bitmex. There are multiple reasons for a trader to trade on Bitmex.

  • No KYC requirements
  • High Leverage
  • Altcoin futures

TL;DR

A negative funding rate means that shorts pay longs.

A postive funding rate means that longs pay shorts.

The funding rate is an attempt to incentivize traders to trade against the trend in order to provide liquidity. You either pay or receive interest every 8 hours.

Future contracts are a legal agreement that allows buyers and sellers to speculate on what the future value of the underlying asset (BTC) will be.

A lot of new traders who have a strong belief in a future price (short term) tend to use much leverage. On Bitmex, your profit and losses are in bitcoin.

At settlement, the futures price must equal the underlying spot price, and if it doesn’t, then you are not trading futures contracts. On Bitmex for their contracts, settlement happens in a 30-minute time-weighted average price. Take the price of BTC on the relevant exchanges, and every minute they snap the price and take a weighted average of that. That determines their settlement price. After settlement occurs, your position is gone/closed.

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Swaps

Many traders don’t like it that their positions “expired.” They often don’t understand why they have no position open anymore. Bitmex created a contract that never expires. They created a “synthetic margin trading instrument” because many traders in crypto understand margin trading, but when they move to the derivative space, they get confused. To solve that issue, Bitmex created a perpetual swap that doesn’t have an expiry date. What they have done is created a never-ending sequence of 8-hour future contracts, and they do charge interest rates based on the premium discount that observed between the actual price of a swap contract and the underlying price of BTC. They take an 8-hour T-wap every minute and check the premium or discount of the swap, and they will charge that as a funding rate in the future. Your funding payment is the size of your position in BTC times the funding rate. They charge this funding every 8 hours.

If you didn’t know what a perpetual swap is, you are probably using that right now — Perpetual dictionary meaning: continuing forever in the same way.

A negative funding rate means that shorts pay longs. In a previous 8 hour period, the swap was trading at a discount to the underlying spot price. So short traders need to pay for their position. You get incentivized for trading against the trend. If the funding rate is positive, longs will have to pay shorts. Bitcoin has been in a bull market for the last couple of years. So generally, shorts will earn BTC by keeping their positions open. However, at the time of writing this, Bitcoin went down from $19000+ to below $6000. Fun story, I had a small long position at $7.3K stuck for months. However, since it was a bear market (at the time of writing this article), I earned BTC for keeping my position open. Now BTC is back to $8K, and I’m pretty happy about that.

The funding you pay or receive:

But this can also be dangerous when the funding rate is, for example, high and you are trading with high leverage. Using high leverage means that your position value is significant. If the funding rate would be 1.5%, and you are using 50x or 100x leverage and the market stops moving or moving into your favor, you could get liquidated just because you have to pay the interest rate. It means you were unable to afford to keep your position open. It can encourage traders to close their trade before the funding rate. Paying “rent” 8 hours if the funding rate is against you can add up quickly on high leverage, which often leads to interesting events. When funding is expensive, traders close their positions right before, leading to high volatility and possibly star wars lightsaber candles.

Another scenario is that someone wants to close their position to avoid paying the funding rate. Still, the market can rally in a “premium” more than the trader has to spend on the funding rate, which can lead to a loss more significant than the funding was about to be. If you want to open trade again, you pay a fee, pay the spread, and most likely pay a premium. The market often overcorrects as traders try to get out of their position before funding rate, and the other side of traders will try to lower their bids or raise their offers.

How to know if you use the Perpetual swap or contracts with an expiry date?

Sentiment

In many cases, when for a prolonged period, there are positive funding rates (longs will pay, and shorts will receive) leads to the price potentially be pushed down temporarily.

In many cases, when for a prolonged period, there are negative funding rates (short will pay, and longs will receive) leads to the price potentially be pushed higher temporarily.

For example, when funding is negative (short will pay, and longs will receive), a majority believes that price will keep going down. Many shorts keep entering and are willing to pay the funding rate.

Retail traders usually lose in the long run and are often wrong.

The longer the funding rate stays at an extreme or keeps getting more extreme, the better the signal potential is for a trend reversal.

Let’s look at an example — Bitcoin 2017 topping in December around 19k. For my trading view chart, I’m using this indicator called “BitMEX Funding and Premium Index,” which is created by NeoButane. When the funding rate was positive and higher than 1% for a prolonged period, the price started to drop.

In March 2020, during the Coronavirus panic, bitcoin crashed, and the funding rate was negative to the extreme. This extreme negative funding rate incentivized some traders to take a long position and receive funding.

Funding Mean Reversion Strategy

After over a year in existence, Bitmex decided to release a blog post about analyzing predictive properties of the funding rate with their question: “can you predict the future price of Bitcoin by the published funding rate?”

Their sample size was 524 funding periods, and this is the number of times that the funding rate was less than or equal to the sigma adjusted test (assuming a negative funding rate).

They concluded that traders use an extreme funding rate as a single to fade/counter-trend. The reason for this is the benefit of receiving funding.

You can find the article from Bitmex here: https://blog.bitmex.com/xbtusd-funding-mean-reversion-strategy/.

Now, this doesn’t guarantee anything, but it might be helpful in your analysis and decision making.

This article is originally written in 2018 but updated in April 2020. A lot more exchanges offer to trade with perpetual swaps like Deribit, FTX, Bybit, BTSE, and FTX.

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