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SOL Funding Rates: What To Know About Exchanges, Risks, & Benefits
Learn how SOL funding rates work and how to put them to work in your trades.
Published: June 8, 2023 | Last Updated: July 6, 2023
Commonly referred to as perpetuals, perpetual swaps, or perps, a perpetual contract works just like a futures contract but doesn’t have an expiry date. Hence, you can hold a position for as long as you wish.
This necessitates exchanges to use a price anchoring mechanism called a funding rate to keep a perp’s price closer to the underlying crypto’s spot rate. Longs pay the funding rate to shorts or vice versa depending on the market conditions.
This article will tell you all about SOL funding rates, how and where to make money through them, and the relevant risks.
SOL Perpetuals And Futures Explained
In a futures contract, two traders agree to buy and sell an asset at a set price before or on a future date. For crypto futures, this pre-set price is the spot price of the crypto at the time of opening the contract.
Another important characteristic of a futures contract is that it’s a type of derivative. A derivative contract derives its value from the asset contained in it. In essence, the two traders entering into a futures contract don’t exchange any cryptocurrency. They merely settle the difference between the opening and closing price of the contract.
How Do Perpetual Contracts Work?
A perpetual contract works just like a futures contract, without an expiry date. As a result, you can keep it open indefinitely if needed. This is one of the biggest reasons why perpetuals are more popular than traditional futures. In particular, SOL perpetuals have significant trading volume as Solana is one of the biggest Ethereum competitors.
As mentioned above, SOL perpetuals don’t have an expiry date. The SOL perpetual traders simply exchange the opening and closing price of the contract at the time of settlement.
The perpetual’s price is kept close to the spot price through a mechanism called a funding rate. Since the two prices are similar, you can trade a SOL perp just like SOL spot, but with the flexibility of going long or short and using leverage.
The funding rate is used for calculating funding fees payable by longs or shorts to their counterparties. It is positive or negative depending on whether the SOL perp’s price is higher or lower than SOL’s spot price.
SOL funding fee = Nominal value of position x Funding rate
Funding rate serves as an incentive for shorts or longs to enter the market during bullish or bearish conditions, respectively. Assume SOL perp is trading higher than the spot rate in a bull market. More shorts will enter the market to earn funding fees and thus pull the perp price down and closer to spot. The opposite happens in a bear market.
The funding fee is calculated and paid on an hourly, 4-hourly or 8-hourly basis on most exchanges.
Positive And Negative SOL Funding Rates
A Positive SOL Funding Rate Means
• SOL perpetuals are trading at a price higher than the SOL spot rate.
• SOL perp traders who are long have to pay the funding rate to traders who are short.
• You can hedge your long positions in the SOL spot market by shorting SOL in perpetuals and earn funding fees, too, in the process.
A Negative SOL Funding Rate Means
• SOL perpetuals are trading at a price lower than the SOL spot rate.
• SOL perp traders who are short have to pay the funding rate to traders who are long.
How Do People Make Money Off SOL Funding Rates?
Arbitrage
Arbitrage is a strategy that helps you take advantage of and profit from the discrepancies in SOL funding rates on different exchanges.
Assume the SOL funding rate is 0.03% and -0.02% on Exchange A and Exchange B respectively, calculated and paid every 4 hours. So, on Exchange A, longs will pay shorts, and on Exchange B, shorts will pay longs a funding fee every hour.
Let’s also assume that you have $20,000 capital and the funding rates remain unchanged for the next 24 hours.
Exchange A
Since Exchange A has a positive funding rate, you open a short SOL perp position on it with $10,000 margin. Your daily earning potential without leverage will be:
($10,000 x 0.008%) x 24 = $19.2
You can earn $96 or $192 by using 5x or 10x leverage, respectively.
Exchange B
Opening a long SOL perp position on Exchange B with $10,000 margin and zero leverage will earn you a daily profit of:
($10,000 x 0.004%) x 24 = $9.6
With 5x or 10x leverage, you’ll earn $48 or $96 per day, respectively.
Total Revenue
Your total daily revenue:
Without leverage = $19.2 + $9.6 = $28.8
With 5x leverage = $144
With 10x leverage = $288
Please note this isn’t a ‘set it, forget it’ strategy. You’ll need to constantly monitor the changing SOL price and funding rates