Understanding Funding Rates and Basis Trades

Why perpetual contracts need a funding rate

A perpetual futures contract has no expiry date, so it needs an ongoing mechanism to keep its price aligned with the underlying spot asset — that mechanism is the funding rate, a periodic payment exchanged directly between long and short position holders.

How the funding rate corrects price

When the perpetual contract trades above spot price, longs typically pay shorts, creating an incentive to short (or reduce long exposure), pushing the contract's price back down toward spot — and the reverse when it trades below spot.

How a basis trade uses this

• A trader might hold a spot position and an offsetting short perpetual position, collecting the funding rate as a form of yield.
• This strategy's returns come from the funding rate, not from the underlying asset's price direction.

What to remember

• The funding rate keeps a perpetual contract's price aligned with the underlying spot asset.
• It's a periodic payment exchanged directly between long and short holders.
• A basis trade combines offsetting spot and derivative positions to collect the funding rate.
• This strategy reduces directional price risk but isn't risk-free.