What is Funding Rate Arbitrage?
There are two types of funding rate arbitrage:
1. Funding rate arbitrage between spot and perpetual contracts
Funding rate arbitrage between spot and perpetual contracts refers to conducting two transactions in opposite directions, equal in quantity, and with offsetting profits and losses in spot and perpetual contracts at the same time, with the goal of earning funding fee income in perpetual contract transactions.
When the funding rate is positive, buy spot and short the perpetual contract with a position equal to the spot, and short to obtain stable funding fee income. This arbitrage is also called positive arbitrage.
When the funding rate is negative, spot leverage borrows currency to sell spot, and perpetual contracts go long with a position equal to the spot leverage sales, and go long to obtain stable funding fee income.
It is important to note that borrowing coins for spot leverage incurs interest. Generally, when the funding fee can cover the interest on spot leverage, it is worth arbitraging, meaning that if the funding fee yield is greater than the spot leverage interest, one can proceed with arbitrage.
Example: Assuming the current BTC price is 20,000 USDT, and the funding rate is 0.03%, using 4,000 USDT for funding rate arbitrage with 1x margin.
1. Buy 2,000 USDT worth of BTC spot and short 2,000 USDT worth of BTC perpetual contracts.
2. Assuming the funding rates are equal, every 8 hours you will receive 2,000 USDT × 0.03% = 0.60 USDT every 8 hours.
3. Collect 0.60 × 3 = 1.80 USDT daily, with an annualized return of 1.80 × 365 ÷ 2000 = 32.95%.
2. Different funding rate arbitrage across different exchanges.
Different funding rate arbitrage across different exchanges is another trading strategy that exploits the differences in funding rates for the same cryptocurrency between perpetual futures exchanges for arbitrage. This involves combining a long position at a lower funding rate from one exchange with a short position at a higher funding rate from another exchange. The funding rate is the payment made periodically between long and short traders to ensure the perpetual contract price stays close to the underlying asset price.
Example: Assume Xiao Ming notices that the funding rate for Bitcoin perpetual futures on Exchange A is relatively high at 0.04%, while the funding rate on Exchange B is lower at 0.01%.
Xiao Ming buys a Bitcoin perpetual futures contract on Exchange B at a price of $60,000 per Bitcoin, while simultaneously selling a Bitcoin perpetual futures contract on Exchange A at the same price of $60,000 per Bitcoin.
If the funding rates between the two exchanges remain unchanged until the funding fees are settled, Xiao Ming simultaneously closes the positions on both exchanges, assuming the price at that time is $61,000 per Bitcoin for both.
This results in a funding fee difference of $18.3 = $61,000 (0.04% - 0.01%) in profit between the two exchanges.
Precautions for funding rate arbitrage strategy
1. Reduce leverage to prevent liquidation. Although funding rate arbitrage can achieve low risk or even no risk due to the consistency between perpetual contracts and spot prices, one must still maintain respect for the market and be wary of the liquidation risks caused by abnormal price fluctuations.
2. Conduct thorough research and carefully select cryptocurrencies. To profit from funding rate strategies, one must research the relevant cryptocurrencies and details about their funding rates, and ideally choose those with high rates and long durations.
3. Reasonable capital investment to control trading risks. In some small cryptocurrencies, the market depth may be insufficient, and investing a large amount of capital in trading may cause significant slippage.
4. Do not frequently change cryptocurrencies to avoid incurring high trading fees due to high-frequency rebalancing and currency swaps, making it difficult to cover trading costs with the profits earned.
In summary, funding rate arbitrage can achieve stable returns, but it does involve risks. In extreme cases, when prices surge in either direction, the position on the other side may be at risk of liquidation. Therefore, when engaging in funding rate arbitrage, one needs to consider how to control position size to avoid liquidation, transaction fees, market depth, and other factors.
