Funding Rates

In the realm of perpetual contracts, a pivotal element is the funding rate. Different from traditional futures, perpetuals lack a preset expiration. Hence, they can be retained indefinitely. This characteristic changes the typical dynamics seen in futures where prices converge with the underlying asset's price as expiration nears. Instead, perpetuals use funding rates to ensure their prices closely follow the spot prices of the underlying assets.

Mechanics of Funding Rates

Funding rates serve as a balancing mechanism. They can be perceived as the "interest" traders pay, based on the perpetual contract's current market conditions. These rates can either add to the cost or reduce it, influencing traders' decisions on maintaining their positions. The essence is to ensure the perpetual contract's mark price doesn't stray too far from the asset's spot index price.

• Positive Funding Rate: Occurs when the Perpetual Mark Price is above the Spot Index Price. This situation implies that traders with long positions compensate those with short ones.
• Negative Funding Rate: Inversely, it's when the Perpetual Mark Price is lower than the Spot Index Price. Here, traders with short positions compensate their counterparts with long ones.

By modulating these incentives, WMX ensures that if the perpetual price leans too high or low compared to the spot index price, corrections occur, bringing the price closer to the spot index.

Importance of Open Interest

Open Interest embodies the cumulative total of all active positions in a particular perpetual market. The magnitude of the funding rate, be it positive or negative, dictates the "interest" exchanged between long and short positions during a given funding interval, which is a fraction of an open position's size.

Real-World Implications

Take the ETH perpetual as an instance. Should its funding rate be positive, those with long ETH positions would compensate those with short positions for the prevailing period. Conversely, if negative, traders with short ETH positions would do the compensating.

How we derive Funding Rates

WMX employs specific market facets to compute funding rates for its perpetuals:

• Spot Index Price: More details in the Oracle Section.
• Perpetual Contract Mark Price: This is derived from WMX's internal perpetual price gauge.
• Funding Interval: Represents the time duration when the "interest" is exchanged. For WMX, this duration is one hour.

The actual computation involves referencing the funding index: