Funding Rates, and why you should use DeFi!
Perpetual contracts have emerged as a popular product, allowing traders to speculate on the future price of cryptocurrencies without an expiry date. A crucial element of perpetual contracts is the funding rate mechanism, which ensures the market price of the perpetual contract stays closely aligned with the spot price of the underlying asset. This article delves into funding rates, how they work, and why you should use DeFi!
What are Funding Rates?
Funding rates are periodic payments made between buyers (long positions) and sellers (short positions) of perpetual contracts. The direction of these payments depends on the difference between the perpetual contract price and the spot price of the underlying asset. Essentially, the funding rate mechanism incentivizes traders to take positions that bring the perpetual contract's price closer to the underlying asset's market price.
https://www.coinglass.com/FundingRateHeatMap
Funding rates are exchanged directly between traders at specific intervals, commonly every 8 hours. This means traders will receive or pay funding based on their open positions at these predetermined times.
Traders holding positions over multiple funding intervals may experience a significant impact on their returns, which could be anywhere from a couple of days to years. The cumulative effect of funding rate payments can erode profits or enhance returns, depending on the market direction and the trader's position.
Funding Rates in DeFi
In DeFi, there are several types of protocols you can use to open long or short positions on your assets; there are examples as “dydx” which is a perpetual contract trading dApp, very similar to any CEX; and lending protocols, which can be used to borrow the needed funds to multiply your exposure to a particular asset. This is where Summer.fi comes into play. Perpetual contracts trading apps, suffer the same issue as Centralized Exchanges, they are too expensive… you can see in this image that the Annualized APY for longing ETH is 143%.
“Funding rates” in lending protocols are named different, but work the same way and serve the same purpose, it is the cost of the borrowed capital used to multiply your position.
Why Summer.fi?
Using Summer.fi you can choose the protocol that better fits your needs and select your multiplier, which can go from 1.1x up to 18x, depending on the protocol and the liquidity available. For example, you can long wBTC for a fixed 6.70% annually on Spark using Summer.fi, instead of paying 120%,130%, or 145% on CEXes or other dApps. This is also where protocol architecture comes into the scene. Maker and Spark are fixed rates protocols, which means that the “funding rate” is predictable; it can only be changed by their governance after voting, which gives you predictability in your position, the downside is that multipliers are usually smaller. On the other hand, protocols such as Morpho, Aave or Ajna have variable rates depending on usage, making it less predictable. However, in most cases, even with a 100% utilization rate, it is lower than CeFi.
Let’s do an example: For two distinct positions, each opened with an investment of $1,000,000 for one week, the costs incurred through funding rates are markedly different due to the variance in their annualized rates. In the first scenario, where the annualized funding rate is set at a substantial 145%, the trader would incur a funding rate fee of approximately $27,808.22 over the week. On the other hand, the second position, characterized by a much more conservative annualized funding rate of 6.70%, would see a significantly lower fee of around $1,284.93 for the same period, translating into a remarkable cost reduction of 95%.
In conclusion, DeFi apps like Summer.fi offer a compelling alternative for those seeking to engage in multiplied positions with significantly lower funding rates than traditional CeFi platforms, potentially saving investors up to 95% in fees. By allowing users to select from various protocols that best suit their needs and preferences for, from as low as 1.1x to as high as 18x, DeFi brings flexibility and efficiency not available in Centralized Exchanges.
Now you know, no more wasting money on funding rates; come to DeFi, come to Summer.fi
Getting in touch
If you have any questions regarding Summer.fi, contact us at support@summer.fi or our social media.