An introduction of perpetual arbitrage trading strategies across different platforms

Introduction

Funding rate is an essential mechanism in the cryptocurrency derivatives market, particularly in the context of perpetual contracts. This concept is primarily used to balance power between long and short positions.

In MYX protocol, the funding rate refers to fees that traders with long or short positions must either pay or receive, depending on the comparison between the platform’s liquidity available for longs versus shorts.

If the liquidity available for long positions is less than that available for shorts, then traders with long positions will pay a funding fee to those holding short positions, and vice versa. The funding rate is adjusted in real time based on the liquidity comparison between longs and shorts on the platform, and is collected every hour. The purpose of this mechanism is to motivate market makers and arbitrageurs to balance these positions, ensuring a higher utilization rate of the MLP for enhanced capital efficiency.

Utilizing the market rate differences in crypto exchanges

The strategy of funding Rate arbitrage trading

The primary objective of funding rate trading strategy is to profit from the differences in funding rates across various markets or trading platforms.

When engaging in funding rate arbitrage, it is essential first to understand how different platforms charge their funding rates and at what times these charges are applied. Typically, traders initiate short positions on platforms where funding rates are positive to earn those rates. Concurrently, they hedge these positions by opening long positions on platforms where funding rates are lower or negative. This approach aims to capture the differential between the rates, thereby generating profit.

Calculating the Funding Rate Differences

For instance, let’s assume Alice notices that the funding rate for BTC/USDC perpetual futures contract on MYX exchange is higher, at 0.013%, compared to Binance’s BTC/USD contract, which has a lower funding rate of 0.01%. Alice buys one BTC perpetual future contract on Binance at a price of $60,000 while simultaneously selling one on MYX at the same price. The long and short positions offset each other in terms of profit and losses, while Alice profits from the funding rate difference.

The funding rate on MYX is collected every hour, whereas on Binance, it is collected every 8 hours. Alice’s operation on MYX involves a short position to collect the higher funding rates, while on Binance, she takes a long position as a hedge. The daily earnings are calculated as follows:

• At MYX, the daily funding rate earnings = 0.013% * 24(hourly settlement) = 0.312%
• At Binance, the daily funding rate expense = 0.01% * 3(8 hourly settlement) = 0.03%
• Therefore, Alice’s net profit per day = 0.312% — 0.03% = 0.282%, which is equivelent to an annualized return of 0.282% * 365 = 102.93%

Since Alice needs to provide collateral in two separate positions on MYX and Binance, her actual rate of return is 102.93% / 2 = 51.465%. This strategy allows Alice to capitalize on the differential between funding rates on two platforms. However, it requires close monitoring of market fluctuations and timely adjustments to the trading strategy to maximize returns.

Using Leverage

Appropriate use of leverage can increase funding rates returns. In the above example, if Alice opts to use leverage, it could boost her earnings. Suppose Alice decides to employ 4x leverage; her annualized returns would then be 51.465% * 4 = 205.86%.

However, excessive leverage could necessitate frequent rebalancing. When holding positions for funding rate arbitrage, it is crucial to avoid liquidation at all costs. During a liquidation event, Alice would lose a certain amount of maintenance margin. Even if the profits and losses from her long and short positions offset each other, the costs associated with liquidation and the potential failure to re-establish positions post-liquidation can lead to losses.

When using leverage for funding rates arbitrage, it’s important to use lower leverage ratios (below 5x) and to set take-profit and stop-loss orders to manage risks before either the long or short positions face liquidation.

For example:

If Alice’s long BTC position has a liquidation price of $59,000 and her short position has a liquidation price of $61,000, she needs to set a stop-loss order at $59,500 for her long position and a take-profit order at $60,500. Similarly, she should set a take-profit order at $59,500 for her short position and a stop-loss order at $60,500.

Potential Risks

Trading Slippage:

1. Discrepancies in hedging prices can lead to slippage. In highly volatile markets, especially during rapid arbitrage execution, prices can change swiftly, resulting in a mismatch between the execution prices of the hedged parties.
2. Slippage in centralized exchanges can reduce anticipated profits and, in some cases, may even lead to losses.
3. Rapid changes in funding rates, which are constantly adjusted based on platform liquidity or market conditions, require careful timing and management of rate differentials. Positions may need to be closed when arbitrage opportunities diminish or reverse.

Transaction Costs:

1. Exchanges typically charge fees for trading transactions, which can impact the profitability of arbitrage trading, especially when price differentials are small.
2. Considering the impact of fees on profits before executing arbitrage transactions is crucial.

Conclusion

When considering a funding rates arbitrage strategy, traders need to weigh potential risks against rewards and understand the method of funding rates collection across different platforms, particularly in fast-moving market environments. Successful arbitrage relies not only on effective risk management and a keen sense of market dynamics but also on considering the potential impacts of transaction costs and slippage. Through continuous market analysis and timely adjustments, traders can maximize the potential of this strategy, thereby achieving more stable and sustainable investment returns.