# Dynamic Funding Rates ⎊ Area ⎊ Resource 3

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## What is the Mechanism of Dynamic Funding Rates?

Dynamic funding rates are a core mechanism in perpetual futures contracts, designed to align the derivative's price with the underlying spot asset price. These rates represent periodic payments exchanged between long and short position holders. The direction and magnitude of the payment are determined by the difference between the perpetual contract price and the spot price.

## What is the Equilibrium of Dynamic Funding Rates?

When the perpetual contract trades at a premium to the spot price, long position holders pay short position holders, incentivizing short selling and pushing the contract price down toward equilibrium. Conversely, when the contract trades at a discount, short holders pay long holders, encouraging buying pressure. This dynamic adjustment prevents significant divergence between the derivative and the underlying asset.

## What is the Strategy of Dynamic Funding Rates?

Quantitative traders utilize dynamic funding rates to implement various strategies, including basis trading and yield farming. A positive funding rate creates an opportunity for a cash and carry trade, where a trader can earn the funding rate by holding a long spot position and a short perpetual position. Conversely, a negative funding rate can be exploited by reversing the positions.


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## [Genesis of Non-Linear Cost](https://term.greeks.live/term/genesis-of-non-linear-cost/)

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**Original URL:** https://term.greeks.live/area/dynamic-funding-rates/resource/3/