Understanding Default Rates

The standard funding rate used is by most exchanges is 10.95%. It means that the exchanges treat the investment as if the lending rate for crypto was 0% and USDT was 10.95%. So by default, an investor that longs a currency using Futures would pay that amount for the user shorting the currency.

In reality, however, the interest rate of the US dollar (Fed funds) stands at around 4% and multiple crypto projects offer staking rewards with much higher rates. On an efficient market, the futures should reflect the difference in interest rates between the coins. So when the staking rewards are higher than 4%, the investor should pay to short, rather than earn. Otherwise an investor can simply profit by staking the coin and shorting the future.

With the default rate not reflecting the market, the only way for the futures to have the "correct" funding rate is adjusting it via the Premium Index. But this is not easy to do. On Gate.io and Binance, the funding rates are calculated by the following formula:

Premium Index = [Max (0, Depth Weighted Bid Price - Mark Price) - Max (0, Mark Price - Depth Weighted Ask Price)]/Index Price

Funding Rate(F) = Premium Index(P)+clamp(interest rate-Premium Index(P),0.05%-0.05%)

This (SOURCE) goes in-depth on how the formulas work and explains the numbers involved.

The first formula means that regardless of market conditions, the Premium Index would only start to be adjusted if either the impact bid is higher than the mark price or the impact ask is lower than the mark price. In other words, the Premium Index would only start to be adjusted if there are people willing to sell at least $4000 worth of contracts below what the exchange considers a fair price. Many futures don’t achieve that simply due to lack of liquidity.

The second formula means that the premium index would need to be at least 0.05% to impact the funding rate, making it even harder to accomplish. For reference, a 0.05% funding rate every 8 hours is a 54.75% annualized rate.

So while it would be possible for the futures to have a funding rate in line with what we would expect from the interest rates involve, this is very hard to achieve in practice, due to how the rates are defined.

The results are felt on multiple exchanges, but a good example is Gate.io where over the past 7 days, 133 out of the 181 Futures tracked by Coinglass had an accumulated 0.21% funding rate, meaning that their funding rate was 0.01% on every interval and investors were paid to short the tokens. Including clear cases for arbitrage.