In crypto markets, traders are usually fast, or at least most retail investors. This causes an interesting phenomenon as it encourages arbitrage desks and whales to sell futures contracts while simultaneously purchasing on regular spot exchanges.
The above chart shows that there was an incredible profit of 240% in 2021 as crypto reached a total capitalization of $ 2.58 trillion on 11 May. A 53% correction after the following week made a low of $ 1.3 trillion, reducing open interest futures by $ 32 billion.
Perpetual futures automatically rebalance daily
Unlike regular monthly contracts, fixed futures prices are the same as for regular spot exchanges. This makes the life of retail traders much easier as they no longer need to calculate the futures premium or manually roll the position near the expiry.
The funding rate allows this spell to occur, and when they are demanding more leverage, it is taken from longs (buyers). However, when the situation is reversed and shorts (sellers) are more leveraged, the funding rate becomes negative, and they become fee-payers.
Note how AAVE presented a positive funding rate during the past three months, in addition to one-two 8-hour instances. Typical positions include leveraged longs paying the fee, and oscillating from 0% to 0.30% per 8-hour period, which is equal to 6.5% per week.
On May 19, as the cryptocurrency market collapsed, futures open interest of AAVE fell from $ 200 to $ 82 million, until its position on the stop order was closed or forcibly liquidated.
After trying to stabilize for a few days, the 8-hour funding rate permanent contract is now negative 0.10%, which is equivalent to 2.1% per week. In this situation, shorts (sellers) pay a fee, giving buyers an incentive.
A similar pattern unfolded on Polygon (MATIC), which dropped 62% on May 19, to an all-time high of $ 2.70 on the previous day.
In the case of MATIC there has been a negative 0.20% and some 8-hour periods of low funding rates, which is equivalent to 4.3% per week. While this rate fluctuates enormously, it creates pressure for short sellers to close their positions as it reduces their margins.
The opportunity is usually short-lived
A negative funding rate creates a safety net for buyers as there are incentives to gather strength and try to squeeze short-sellers.
This is why some analysts refer to the negative funding rate as a purchase indicator. However, as the shorts close their position, the position automatically balances, and the funding rate becomes ineffective.
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