Futures funding rate is the cost of borrowing money from your broker. It is also known as the overnight rate, because it refers to the amount that a securities dealer will lend you to make trades. This is an important concept to know about if you are interested in investing in futures contracts, forex options, crypto or other highly leveraged financial products.
What Is A Future Funding Rate?
Futures funding rate is a little-known phenomenon that will impact the futures trade differently. Understanding how the futures funding rate works and its future ramifications on the futures trade are critical to making money on Wall Street.
The futures funding rate is used to set a minimum return for investors in new issues of Treasury securities. It was created when Congress passed the Securities Act of 1933 and regulated the stock market.
The goal of this act was to protect investors by requiring brokers to execute trades with their own money rather than borrowed money or customer funds. In order to make sure that broker-dealers have enough money, the futures funding rate was established as the minimum return for anyone who holds long positions in Treasury securities for more than seven days.
To ensure that the broker-dealers have sufficient funds, they have to maintain a reserve balance of cash or cash equivalents equal to 10% of all customer receivables plus 35% of customer receivables from short positions in Treasury securities. The only exceptions are government securities brokers, who must maintain a reserve balance equal to 100% of customer receivable from customer accounts.
Components Of Funding Rates
The Funding Rate is the rate of return that an investment in a crypto asset receives. It is also sometimes referred to as interest on the bond. The key components of the funding rate are interest rate and premium.
In a bond, the interest rate is how much you will receive from your investment over time. Interest rate is the percentage you get for holding this investment for a certain period of time. If you invest $100 for one year, at 5% interest per year, you will receive $105 after 1 year.
The premium is how much extra you will get from your investment over time. Premium is calculated by taking the present value of your investment and subtracting it from $1 (the present value of $1). This can also be thought of as what your investment would be worth if it compounded continuously at its current funding rate.
In crypto-bonds like CDTs, there is no maturity date; therefore, there are no coupons or principal payments generated by the bonds. Instead, these bonds pay out their entire funding rate as an upfront premium at their maturation date and no longer exist on the market after these dates are reached.
Impact of Funding Rates To Traders
Crypto traders’ funding rates affect their trading results. Funding rates are the interest rate banks charge you when you hold an open position overnight. Let’s say you have an open position worth $20,000 at a specific exchange, and in the morning your funding rate is -0.2% per day.
So if you don’t close your position before the end of the day, the exchange will take away $200 from your account for holding that position overnight. In this example, if you are holding a long position (buying Bitcoin), then -0.2% per day means that if the price goes up by 1%, then after one day your profit will be $19,800 instead of $20,000.
The higher this funding rate is, the more money you lose if you hold an open position overnight instead of closing it before the end of the day.
Role Of Funding Rate In The Crypto Market
The role of Funding Rate in the crypto market is very important, but it is often overlooked. It has a major influence on the crypto prices and market.
The funding rate is the profit rate of a cryptocurrency exchange, which is the difference between the buyers’ and sellers’ rates. The bigger the difference, the bigger the funding rate. The funding rate has a direct impact on the value of cryptocurrency, because it is a part of it, which means that every increase or decrease in the funding rate will have an immediate impact on the value of cryptocurrency.
Because if it increases, more people will buy cryptocurrency and if it decreases, fewer people will buy cryptocurrency. So from this point of view, we can say that if there is no change in the crypto market and all other factors stay constant, then an increase in the funding rate will lead to an increase in crypto market value and vice versa.
Many experts argue that an increase in interest rates will increase risk aversion among investors and cause a significant drop in cryptocurrency prices. However, if we look at facts, we will see that even though interest rates are constantly increasing, this doesn’t have a negative impact on cryptocurrency prices.