Trading in the world of crypto and finance is layered with complexities and nuances. One such intriguing area is the domain of futures and their fascinating mechanisms. In this article, we’ll demystify the concept of futures funding and answer some common questions that traders often have.
1. Why Do We Even Need Futures Funding?
You might be wondering why there’s a need for something like futures funding, especially when it doesn’t exist in the spot market. Well, futures funding exists to tether the futures contract closely to the real-world scenario, i.e., the spot market. Let’s put it this way: If a trader wants to manipulate the price without actually buying coins in the spot market, they’ll have to pay a sort of “penalty” in the form of funding. On the flip side, those who decide to hold onto their positions during volatile times get rewarded — think of it as a sweet treat for their audacity!
2. Deciphering the Size of Funding
While the concept might sound intricate, determining the size of funding is surprisingly straightforward. If the futures price happens to be higher than the spot market price, those holding long positions end up paying the shorts. This is an incentive for long traders to close their positions, causing the futures price to reconcile with the spot market price. However, the exact formula to calculate the funding rate might be a tad more complex. Curious souls can find it with a simple Google search.
3. What’s the Exchange’s Cut in All of This?
You’d be forgiven for thinking that the exchange might take a slice of this funding pie. But in reality, exchanges don’t pocket any of it. Every bit of the paid funding gets redistributed among the traders. This is due to an interesting fact: the number of long contracts always perfectly balances out with the number of short contracts.
4. The Perpetual Dance of Longs and Shorts
Here’s where it gets mind-boggling for some: How is it that the number of long positions always equals the number of short positions? The answer lies in the fundamental mechanics of trading. Whenever you’re buying from the order book, it implies someone else is selling. Price movements arise from the scarcity of either buyers or sellers at a specific price point.
To simplify, let’s consider a hypothetical:
Scenario 1: Trader A buys 1 contract, initiating a long position. This is sold by Trader B, who then starts a short position. The market equilibrium is maintained with 1 long and 1 short.Scenario 2: Trader A chooses to close out his long, selling his contract to Trader B who opens another long position. Now, while Trader B holds a new long, he also retains his initial short. The balance is still intact with 1 long and 1 short in the market.Scenario 3: Trader B decides it’s time to close his short. He buys a contract (from his own long position) to offset it. At this juncture, all positions are squared up, and we’re back to zero.
In conclusion, the realm of derivatives, particularly futures, is a tapestry of strategies, mechanisms, and checks and balances. Whether you’re a seasoned trader or a newbie, understanding these nuances can significantly enhance your trading acumen and success. Happy trading! 🚀
Originally published at https://tradermake.money on November 3, 2023.
Unlocking the Secrets of Futures Funding in Crypto Trading was originally published in Coinmonks on Medium, where people are continuing the conversation by highlighting and responding to this story.