Funding

Learn about why funding is important

Funding is a critical mechanism that ensures the price of perpetual swaps remains aligned with the value of the underlying asset. On Synthetix Exchange, the funding rate and premium/discount mechanism have been designed with unique features to enhance market balance and trading efficiency.

The Basics of Funding

Funding works similarly to an interest payment. It represents a percentage of your position size, adjusted for leverage, and is paid or received at regular intervals.

• Positive Funding: Traders in long positions pay those in short positions.

• Negative Funding: Traders in short positions pay those in long positions.

Why Does Funding Exist?

Funding exists to balance the market. For every long position, there must be a short position. On Synthetix Exchange, liquidity providers pool their assets in vaults to facilitate these trades. Funding rates incentivize traders to take positions on both sides of the market, ensuring balance and reducing skew.

Risks of Funding

While funding is a key part of market balance, it introduces risks for traders:

• Profitability Impact: Funding reduces the profitability of a trade over time.

• Liquidation Risk: High funding rates can lead to liquidation, especially when using leverage.

  • For example, an hourly funding rate of 0.01% annualizes to about 87%. A position at 2x leverage could face liquidation in less than six months if the price remains flat.

  • At 25x leverage, this timeframe shrinks to approximately two weeks.

Advantages of Funding

Funding isn't just a cost—it can also be an opportunity:

• Boost to Profitability: Traders on the opposite side of the funding payment collect funding, which can enhance profits.

• Advanced Strategies: Funding payments enable strategies like basis trading and funding rate arbitrage.

  • Basis Trading: Short an asset with positive funding while holding it in spot markets.

  • Funding Rate Arbitrage: Open opposing perp positions on different exchanges to capitalize on funding rate differences.

These strategies often leverage Delta Neutral approaches, balancing short and long exposure to reduce directional risk.

How Funding Works on Synthetix Exchange

Funding on Synthetix Exchange is influenced by market skew (the imbalance between long and short positions) but operates with a unique approach:

• Positive Skew: Funding rates increase.

• Negative Skew: Funding rates decrease.

• Neutral Skew: Funding rates remain stable.

Unlike traditional systems, funding on Synthetix Exchange changes gradually, even when skew moves rapidly due to large trades. This ensures stability and prevents abrupt changes in funding rates. As a result, some assets may persistently exhibit positive or negative funding, depending on market conditions.

Why This Approach?

"Fair market" funding is rarely zero. Synthetix Exchange's approach ensures that funding reflects market dynamics:

• Bullish Markets: Funding may remain positive.

• High-Inflation Assets: Funding may remain negative.

By finding the equilibrium where longs and shorts are equally incentivized, the system ensures balanced open interest (OI), enabling higher OI caps and more asset listings without increasing risk for liquidity providers (LPs).

Premium and Discount Mechanisms

Synthetix Exchange also includes a premium or discount mechanism tied to skew:

• Premium as Price Impact: Simulates order book liquidity, allowing for large trades and accommodating lower-liquidity assets.

• Premium for Arbitrage Incentives: Encourages arbitrage traders to maintain balanced OI and attractive funding rate opportunities.

These mechanisms are designed to stabilize the market, regardless of whether demand comes from a single trader or multiple traders.