Interest Rate Parity

Interest rate parity is a theory in international finance that describes the relationship between interest rates and currency exchange rates. It posits that the difference in interest rates between two countries should equal the expected change in exchange rates between their currencies.

In the crypto derivatives market, this concept is adapted to explain why funding rates exist for perpetual futures. It suggests that the cost of borrowing capital to leverage a position must be reflected in the price of the derivative.

If interest rate parity did not hold, there would be massive arbitrage opportunities that would quickly correct the imbalance. This theory provides the mathematical foundation for understanding how capital flows between different crypto-assets and stablecoins.