1. What is Funding Rate Arbitrage?
Perpetual futures use the spot price as the trading index and employ a unique pricing mechanism called the "funding rate" to ensure the price difference between the futures and the spot market. It helps anchor the futures price to the spot price, forcefully bringing any deviation back to a reasonable level.
When the funding rate is positive, the perpetual futures price is higher than the mark price. In this case, long traders need to pay funding to short traders. Conversely, when the funding rate is negative, the perpetual futures price is lower than the mark price, meaning that short traders need to pay funding to long traders. The funding fee is calculated as follows:
Funding Fee = Position Value * Funding Rate (Funding is charged three times per day)
By assessing the current and projected funding rates, one can determine the direction of perpetual futures and execute two opposite trades of equal quantity and offsetting profits in both perpetual futures and spot markets to capitalize on the benefits provided by the funding rate.
2. Aibit Practical Steps for Funding Rate Arbitrage Strategy
To summarize the operational steps for the funding rate arbitrage strategy: create positions of equal value and the opposite direction in both the spot and perpetual futures markets.
a. Buy cryptocurrency in the spot market.
b. Simultaneously open a corresponding short position with equal value in the perpetual futures market.
c. Close the short position in the perpetual futures market and sell cryptocurrency in the spot market at the desired profit target.
For example, let's consider the BTC perpetual futures with a current funding rate of 0.03% and an expected funding rate of 0.15% for the next period. At this time, you buy BTC spot worth 10,000 USDT. Simultaneously, in the perpetual futures market, you open a short position for BTC with an equal value of 10,000 USDT. Thus, during the next funding rate payment, the expected profit per funding rate payment would be 10,000 USDT * 0.15% = 15 USDT. Assuming the BTC funding rate remains at the same level for a week, the expected profit over the holding period would be 15 * 3 * 7 = 315 USDT. (Note: For ease of understanding, the example does not consider changes in position value due to fluctuations in the coin price during the holding period.)
3. Considerations for Funding Rate Arbitrage Strategy
a. Lower leverage to prevent liquidation. Although funding rate arbitrage can be low-risk or even risk-free based on the alignment of perpetual futures and spot prices, it is still important to maintain caution and guard against the risk of liquidation caused by extreme price fluctuations.
b. Conduct thorough research and choose cryptocurrencies carefully. To profit from funding rate arbitrage, it is crucial to conduct research on the relevant cryptocurrencies and funding rate details. Preferably, select cryptocurrencies with high rates and longer durations.
c. Manage trade risks by allocating funds wisely. Some small-cap cryptocurrencies may have insufficient market depth, resulting in significant slippage when trading with large amounts.
d. Avoid frequent switching of cryptocurrencies to minimize high trading fees incurred by frequent position adjustments or coin changes. Otherwise, the profits earned may not cover the trading costs.