Contango and backwardation
Why do futures trade above or below the current price, and what does a perpetual funding rate tell us about that gap?
In plain words
Contango is when futures trade above the current spot price; backwardation is when they trade below it. Perpetual futures have no expiry, so instead a regular funding payment between longs and shorts replaces that gap: when funding is negative, shorts pay longs, the perpetual side of backwardation.
Why it matters
The futures-versus-spot gap shows which side traders are paying to be on. A positive gap with rising funding can signal a crowded long; a negative one can signal stress or hedging demand. Funding is the live, recurring price of holding that imbalance, so it is a cost or income a position carries every few hours.
In a real week: BTC, week of 21 June 2021
In the week of 21 June 2021, BTC perpetual funding averaged -0.0091% per eight hours, ranging from -0.0529% to 0.01%. BTC fell 2.53% to 34700.34 after touching 28805.00 on Tuesday, but closed in the upper third of its week range, 46.27% below its 52-week high. Mostly negative funding meant shorts were paying to stay short: the perpetual market sat in its version of backwardation.
A common mistake
Treating a negative funding rate as a buy signal on its own. It shows that shorts are paying, not that the downtrend is ending or that longs are safe.