# Overlay: Funding Payments vs Contango/Backwardation

## Traditional Futures

In traditional futures market, when a trader wants to open a position, either long or short, he needs to find somebody, who will take the opposite side. Thus the total amounts of active long and short positions exactly match each other at any given moment of time.

When demand at one side is higher than at the other side, the traders, who want to open positions at the more popular side, pay a premium to the traders at the less popular side. Such payments are known as "contango" when paid from long to short, and as "backwardation" when paid from short to long.

## Overlay

In Overlay market, when a trader wants to open a position, the Overlay protocol takes teh other side for free. Thus, in case of one side is more popular than another, the total amount of active long and short positions could be different.

The protocol tries to adjust this by continuously charging funding payments from the traders at the more popular side and distributing these payments among the traders at the less popular side.

The amount of funding payment charged depends on how big the imbalance between the long and short positions is. This way an Overlay market discovers the fair funding payments level and stabilizes at it. The fair funding payments level could be non-zero for certain markets, and non-zero funding payments level means that long and short positions are not in balance. Thus, such market will stabilize at the state when the total amount of long positions differs from the total amount of short positions, and the protocol will take the market risk without being paid for this. This is the problem.

A solution for this problem could be for the protocol to actually take money from the traders for the risk taken by the protocol. Let's condider the situation when the total longs amount is 1000 OVL and the total shorts amount is 800 OVL. This effecticely means that the protocol owns a short position of 200 OVL. So, when funding payments charged from the long holders are distributed among short holders, the protocol should get (and burn) its share of the payments charged (20% in this example). As long the short holders agree to hold their short positions at this funding payments level, then they probably believe, that such level is enough to cover their risks. Thus the same level sould probably be enough to cover the protocol's risks associated with the short position the protocol implicitly holds.