So far: Every trade pushes the price a little and a big one pushes it more; part of the push fades and part of it stays (lesson 6).
You can trade bitcoin without ever owning one, through a contract that pays as if you held the coin: when bitcoin rises by 100 dollars, the buyer of a contract for one coin makes 100 dollars and the seller loses them.
The classic contract of this kind is a futures contract: a promise to buy something on a set date at a price agreed today. Its price can drift away from the price of the thing itself, the spot price, until the date pulls it back: on the day, a contract to buy bitcoin right now is worth exactly what bitcoin is worth.
A perpetual is a futures contract with the date taken away, so nothing on the calendar pulls its price to spot. Something else has to.
Funding
Every contract has two sides. Whoever bought it is long and gains when the price rises; whoever sold it is short and gains when the price falls, without ever having owned a coin.
The perpetual is measured against an index, a price for the coin built from spot exchanges. At set times the two sides settle up with a payment called funding: every eight hours by default on Binance, every hour on Hyperliquid. When the perpetual trades above the index, longs pay shorts. When it trades below, shorts pay longs.
Move the perpetual's price above and below its index. Watch which way the payment flows.
- Premium over the index
- +0.10%
- Funding rate
- +0.10%
- A $10,000 long pays
- $10
The perpetual costs more than the coin, so longs pay shorts: $10 on every $10,000 they hold, at every funding time. Holding the short now earns something.
The payment is the position times the funding rate. In this toy the rate is simply the premium, the gap as a share of the index: at 0.10% above it, a long holding $10,000 pays $10 at each funding time. Binance and Hyperliquid average the premium over the period and add a small interest term.
While longs pay shorts, a trader can buy a coin on a spot exchange and sell the same amount of the perpetual. One side gains what the other loses, so the trader carries no price risk and collects funding for as long as the premium lasts. This is an arbitrage, and its selling pushes the perpetual's price down toward the index. The next figure starts a week with the perpetual 0.30% above its index.
Choose how many traders buy the coin and sell the perpetual, then run the week. Watch the gap, and what the longs pay.
Start of the week. The perpetual is 0.30% above its index. Run the week with 3 arbitrageurs.
With nobody arbitraging, the premium sits at 0.30% all week and a long holding $10,000 pays $630 in funding. With three arbitrageurs it's down to 0.03% by the end of the week, and the long pays $246. It never quite reaches zero, because arbitrageurs stop once funding no longer covers their fees and the money tied up in the coin.
The gap between a perpetual's price and its index is its basis. Funding charges whichever side holds the price away from the index, and pays whoever helps close the gap.
The maths
With the perpetual at price F, the index at I and a position worth Q dollars:
premium = (F − I) / I
toy funding rate r = premium; a long pays Q · r, a short receives it
Binance's rate for an eight-hour period, with P the premium averaged over the period and an interest term of 0.01%:
r = P + clamp(0.01% − P, −0.05%, 0.05%)
So while P sits between −0.04% and 0.06%, the rate is 0.01%.
Open interest
Every contract has one long and one short, so counting either side counts the contracts still open: the open interest. Each trade has a buyer and a seller, and each of them is either opening a position or closing one.
Pick who buys and who sells, then trade one contract. Watch open interest and volume part ways.
Three contracts open. Every trade has a buyer and a seller. Choose what each of them is doing, and trade.
When both sides open, a contract is created. When both close, one ends. When one opens and the other closes, a contract changes hands and the count stays put. Volume counts every contract traded, so a busy day can leave open interest exactly where it started.
Borrowed money
A perpetual asks only for a deposit, the margin, and the venue lets you hold a position several times bigger. Hold $10,000 of bitcoin on $1,000 of margin and your leverage is 10×: every 1% the price moves is 10% of your money.
If the losses use up the whole margin, the venue closes the position for you before anyone else has to cover them, selling at whatever the book will pay. That is a liquidation. In this lesson's toy it happens when the loss reaches the margin: after a 10% fall at 10×, or 5% at 20×. Binance, for one, steps in earlier, at a smaller amount it calls the maintenance margin (its liquidation rules), and it judges the loss by a mark price rather than the last trade, so one odd trade can't liquidate anyone (how Binance builds it).
A liquidation is a forced sale, and a forced sale walks the price down the book (lesson 5), where it can reach the next trader's liquidation price. Below, 20 traders are all long from 100, each with their own leverage.
Pick how much the crowd borrowed, then let a big seller knock the price down. See whose lines it reaches, and how far it falls.
Everyone is long from 100. At 10×, the highest line is at 96.2. Let the big seller in.
At 2× and 5× nobody's liquidation line is within reach of 96. At 10× the highest line sits just above 96, and each forced sale pushes the price into the next line until half the crowd, 10 of 20, is gone and the price is at 91. At 20× the chain runs through everyone and ends at 86. The big seller moved the price by 4 every time; what changed was how much everyone had borrowed.
Each liquidation closes a long. When the buyer on the other side is a short closing out, a contract disappears, so a cascade can show up as open interest falling sharply while the price falls.
The maths
With margin M on a position worth Q, bought at price E:
leverage L = Q / M
toy liquidation price for a long = E · (1 − 1 / L)
At 10×, from 100: 100 · (1 − 1/10) = 90, a fall of 10%.
In real data
What you learned
- Futures contract
- A promise to buy or sell on a set date at a price agreed now. The date pulls its price to the price of the thing itself.
- Perpetual
- A futures contract with no date. Funding keeps its price near an index instead.
- Funding rate
- What longs pay shorts at each funding time when the perpetual is above its index, or shorts pay longs when it is below, as a share of the position.
- Basis
- How far the perpetual's price is from its index, often in basis points. Funding charges whoever holds it apart.
- Open interest
- The contracts still open, each with one long and one short. Opening and closing change it; a contract changing hands doesn't.
- Leverage
- A position bigger than your margin. When losses use up the margin the venue sells you out, and that sale can push the price to the next trader's liquidation price.
Check yourself
1. A perpetual trades at 100.20 while its index is at 100.00. Who pays funding?
2. Open interest is 3. Someone opening a new long buys from a long who wants out. What is open interest after the trade?
3. You hold $10,000 of a perpetual on $1,000 of margin. Under this lesson's toy rule, how far must the price fall before you are liquidated?