The funding rate heatmap is a useful tool for crypto investors. In this guide, I’ll explain what it is, how it works, and how to use it correctly in your strategy. Especially when it comes to managing risk and avoiding big losses. This guide was first published in March 2024, but was updated to include a video version in July.
Contents
YouTube video version of this guide
Understanding perpetual swaps in crypto
Before we jump into the funding rate heatmap, we first need to understand how perpetual swaps work in crypto. Perpetual swaps (or “perps”) trade on crypto exchanges and track the prices of digital assets like bitcoin (BTC) or ether (ETH). Perps are a type of futures contract (derivative). Normal futures contracts have an expiration date – but not perpetual swaps (because they’re “perpetual”).
Perps allow investors to trade crypto with extreme leverage. For example, Bob wants to enter a long (buy) trade for $100,000 via a bitcoin perp – but he only has $1,000 in his trading account. So, Bob takes a 100X leverage long position with his $1,000 to boost his trade size.
This could work great for Bob if the bitcoin price goes up (since he’d earn profits on a $100,000 position). But his $1,000 account would be completely wiped out (liquidated) if the price dropped by 1%. Thanks for playing.
How funding rates work for perpetual swaps
Even if Bob was printing money from his trade, he could have another big expense on his hands: perpetual swap funding rates. These funding rates change every eight hours or so – depending on the exchange Bob uses and the general state of the crypto market.
Here’s how it works. When the crypto market is bullish and prices keep rising, there are typically more traders taking long (buy) positions than short (sell) positions. In that case, long traders pay “positive” funding rates to short-sellers (who essentially earn funding rates for betting against the market). And when the market is bearish and prices keep dropping, it can be the opposite: long traders might earn a funding rate from short-sellers (aka “negative” funding rates).
Funding rates incentivize big traders and market makers to go long or short to pick up fees. This funding rate mechanism keeps perp prices in sync with actual crypto prices.
Side note: BitMEX exchange co-founder Arthur Hayes and his team introduced perpetual swaps in 2016. I’ve had my fair share of fun trading on the ol’ “Bitcoin Mercantile Exchange” back in the day (but with much less leverage than Bob).
The crypto funding rate heatmap explained
Perpetual swap traders should keep a close eye on funding rates. Because when those fees work against them, they can pay a lot of money to stay in their trades. I’ve included a snapshot of the funding rate heatmap below, from CoinGlass. It color-codes the yearly funding rates for different crypto perpetual swaps over time.
When a box turns fully orange, it means long traders are paying 100% or more of their entire position size per year in funding rates. I.e. Poor old Bob would need to cough up $100,000 per year in funding fees to stay in his 100X leverage long position (assuming the same 8-hour funding rates). But when a box is greener, funding rates are closer to zero. And when it starts turning purple, Bob would be collecting funding fees from short-sellers (assuming he isn’t liquidated beforehand, that is).
How to use the crypto funding rate heatmap in your strategy
Long traders don’t mind paying expensive funding fees when crypto prices keep rocketing higher each day. That’s because their profits are consistently compensating them for those fees. But they can lose money fast when prices drop or go sideways for too long. So, when the juice is no longer worth the squeeze, they start selling out of their long positions.
But it gets worse. Perp traders can also become forced sellers if their stop-losses get breached, or if the exchange liquidates them (like Bob). That’s why you often see a quick 10-30% “leverage flush” to the downside in crypto. This can also happen in raging bull markets (because that’s when funding rates usually go up the most). Just look at what happened to Ethereum in the chart below – the ETH price dipped 16.4% in a few hours, before carrying on with the rally.
So, as a general rule, it’s best to keep your guard up when you see the funding rate heatmap burning orange for most coins. It usually means a leverage flush could be just around the corner. And it may not be the safest time to ape into your favorite altcoin.
Just keep in mind that funding rates can sometimes stay elevated for longer than you (and Bob) can stay solvent. So, for the love of God, don’t try to short a crypto bull run just because you see an orange heatmap.
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Key points
- Perpetual swaps (perps) are futures contracts that track crypto prices. They’re “perpetual”, so they never expire.
- Just because perps offer massive leverage, doesn’t mean you should use it. Don’t be like Bob.
- The funding rate heatmap color-codes the yearly funding rates for different crypto perpetual swaps over time. The more orange you see, the more cautious you should be.
