Perpetual swaps are the most traded instrument in crypto by a wide margin, and yet most people trading them do not fully understand how they work. The funding rate mechanism alone is responsible for billions in wealth transfer between longs and shorts every year.
A perpetual swap is a futures contract with no expiration date. Traditional futures converge to spot price at expiry, but perps need a different mechanism to stay anchored. That mechanism is the funding rate, a periodic payment between longs and shorts that incentivizes the perp price to track the spot index.
When the perpetual price trades above the spot index (contango), the funding rate goes positive and longs pay shorts. This creates an incentive for traders to short the perp and buy spot (a cash-and-carry trade), which pushes the perp price back down toward spot. When the perp trades below spot (backwardation), shorts pay longs, incentivizing the reverse.
Funding payments happen every 8 hours on most exchanges but some platforms use different intervals. The rate is typically a combination of a fixed interest rate component and a premium or discount component based on the basis between perp and spot prices. During extreme sentiment, funding can reach 0.1% or more per 8-hour period, which annualizes to over 100%. Holding a leveraged position through periods of extreme funding can be enormously expensive.
The mark price versus last price distinction matters for liquidation purposes. Most exchanges use a mark price derived from spot index prices rather than the last traded price on the perp itself. This prevents manipulation where someone could briefly spike the perp price to liquidate positions. Understanding which price your exchange uses for liquidation calculations is essential.
Basis trading, where you simultaneously go long spot and short the perpetual to collect funding, is one of the most popular market-neutral strategies in crypto. During bull markets, when funding is persistently positive, this trade can yield 20-40% annualized with relatively low risk. The main risks are exchange counterparty risk and the possibility that funding rates turn negative during bear markets or corrections.
Position sizing on perps needs to account for the funding drag. A 10x leveraged long position paying 0.03% funding every 8 hours is losing about 0.09% per day just to funding, which is 33% per year. That is a significant headwind that many leveraged traders overlook when calculating their expected returns.