Understanding Margin Trading and Funding Rates

Author: Augustus

First write up

Derivatives vs Futures trading on margin

A lot of traders don’t like that their positions “expire”, in response Bitmex created a contract that never expires; a “synthetic margin trading instrument”

What they have done is created a never ending sequence of 8 hour future contracts and charge an interest rate that is based on the premium discount that is observed between the actual price of a swap contract and the underlying price of BTC.

If a position is held open for a long period of time this can result in

a) a large loss of position or even liquidation

b) a large gain on position for simply just holding your position open

A negative funding rate means that shorts pay longs. In a previous 8 hour period, the swap was trading at a discount to the underlying spot price. So traders who are short need to pay for their position. You basically get rewarded to trade against the trend. If the funding rate is positive, longs will have to pay shorts.

For this reason it is unwise to use high leverage (>25x) near funding times, as you can lose a large portion of your position or even be liquidated within minutes of opening your position (unless of course your scalping for a short term trade)

Thus, for long term trades it is best to stick with 2.5–5x leverage, so your margin position isn’t hurt badly from funding rates.

This is where it gets fun…how to make free money via Bitmex’s funding rate…

You can simply short on 1x leverage only when the funding rate is positive and when the funding rate turns negative you can change your position back into USD or whatever your native currency may be (I’m american), so long as the trading platform you are using provides enough liquidity.

An example of how this works with the exchange Bitmex, and their Perpetual Swap Contract for bitcoin. (Doesn’t have to be only bitcoin, you can use FX, other derivatives, etc…)

For simplicity say 1 Bitcoin (BTC) = $10,000 USD

The funding rate is positive, thus we can make free money by shorting in this scenario.

By shorting on 1x leverage we have hedged our position so that no matter what happens to bitcoins price, we will only profit the funding rate now

If BTC drops 10% we recieve 10% more BTC but that BTC is worth 10% less, versa if BTC goes up 10% we loss 10% of our BTC position, but the BTC we have is worth 10% more now….

Thus, if we open a hedged 1x short when the funding rate is positive, we can keep that hedged position, and also receive the funding rate, in the above picture that would be (.0503%) every 8 hours, while small, doing this frequently and allowing it to compound every 8 hours can lead to large gains… and especially more % earned than a bank’s interest rate or a T-bond would provide by far.

Partial author credits to RNR.

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