What is funding rate and how does it work?

Funding rates are periodic payments exchanged between traders in cryptocurrency futures markets. When a perpetual futures contract (a derivative that never expires) trades at a premium above the spot price, traders holding long positions pay shorts, and vice versa. This mechanism keeps futures prices aligned with actual market prices. Funding rates typically occur every 8 hours and are expressed as percentages. For example, a 0.05% rate means long holders pay 0.05% of their position value to short holders. These rates incentivize traders to take positions that balance supply and demand, preventing extreme price divergence. Understanding funding rates is crucial for leveraged traders, as high rates signal overbought conditions and increased liquidation risk.