Original author: The Black Swan
Original translation: Shen Chao TechFlow
In the crypto perpetual contract market, price deviations often occur, and traders can exploit these price errors for profit.
"Cash and Carry Trade" is a classic profit strategy that allows traders to gain profits from the differences between perpetual contract prices and spot prices.
Funding Rate Arbitrage - Earn 25%-50% passive income annually through cash and carry trade strategy?
In the crypto perpetual contract market, price deviations frequently occur, allowing traders to profit from these price errors. "Cash and Carry Trade" is a classic strategy specifically targeting the differences between perpetual contracts and spot prices, enabling traders to achieve profits easily.
Through this strategy, traders can perform arbitrage operations on centralized exchanges (CEX) and decentralized exchanges (DEX) without incurring high fees. Specifically, you can establish a spot long position on the asset while selling the corresponding futures derivatives. When the market overall leans towards the long side (i.e., when the price premium is high), you can gain additional income from the funding rate. If you find this a bit complex, don't worry, I will explain it in a way that is easy to understand.
What is the funding rate?
The funding rate is a periodic fee that traders need to pay or receive based on the difference between the perpetual contract price and the spot market price. The magnitude of this rate depends on the skew of the perpetual contract market and the degree of deviation of the perpetual contract price relative to the spot market.
In simple terms, when the trading price of perpetual swap contracts is higher than the spot price (i.e., premium), the deviation on trading platforms like Binance, Bybit, dYdX, or Hyperliquid becomes positive, at which point long traders need to pay the funding rate to short traders. Conversely, when the trading price of perpetual swap contracts is lower than the spot price (i.e., discount), the deviation becomes negative, and short traders need to pay the funding rate to long traders.
What we need to do is essentially mimic the operating method of Ethena Labs: going long on the spot ETH while shorting the ETH perpetual contract. But the difference is that we will operate it ourselves and choose assets that interest us (hint: it doesn’t have to be ETH).
If you don't want to read the previous content, I will try to explain it in simple terms.
Assuming we take Ethereum as an example, we want to take a long position on ETH (preferably staked ETH).
We can use stETH (annualized yield of 3.6%) as an example while shorting $ETH on the perpetual contract market (for example, on Binance or Bybit).
When we simultaneously take long and short positions in equal amounts of ETH, our portfolio is in a "Delta Neutral" state. This means that regardless of how ETH's price fluctuates, we will not incur losses or profits due to price changes.
"Delta Neutral Strategy" is an investment approach that avoids market price fluctuation risks by balancing long and short positions. For example, if I open a long position of 1 ETH and a short position of 1 ETH at the same price, then regardless of how the market price changes, my overall portfolio value will not be affected (ignoring fees).
In this strategy, our profits come from two parts: staking rewards of ETH and funding rate income.
The funding rate is a mechanism used to adjust the difference between the prices of perpetual contracts and the spot market. Its role is similar to the interest cost in spot margin trading, ensuring that the prices of perpetual contracts do not deviate from the prices of the spot market by regulating the capital flow of both long and short parties.
The settlement method for the funding rate is as follows:
The funding fee is a direct settlement fee between the buyer and seller, usually settled at the end of each funding interval. For example, with an 8-hour funding interval, the funding fee will be settled at 12 AM, 8 AM, and 4 PM UTC.
At decentralized exchanges such as dYdX and Hyperliquid, the funding fee is settled hourly, while Binance and Bybit settle every 8 hours.
When the funding rate is positive, long position holders pay funding fees to short position holders; when the funding rate is negative, short position holders pay funding fees to long position holders (this usually occurs in a bull market, which I will explain in detail later).
Only traders who hold positions at the time of funding settlement will pay or receive funding fees. If you close your position before the funding settlement, no funding fee will be incurred.
If a trader's account balance is insufficient to pay the funding fee, the system will deduct from the position margin, which may cause the liquidation price to be closer to the mark price, thereby increasing liquidation risk.
Let’s analyze the funding rates shown in the image. The funding rate calculation mechanisms used by perpetual contract exchanges on different chains may vary slightly, but as a trader, you need to understand the time period for funding fee payments/receipts and how the funding rate fluctuates over time. Below is the method for calculating the annualized return (APR) based on the funding rate shown in the image:
For Hyperliquid:
0.0540% * 3 = 0.162% (1-day APR)
0.162% * 365 = 59.3% (1-year APR)
It can be seen that Binance's funding rate is relatively low, with an annualized yield of 31.2% (calculated in the same way). Additionally, there are arbitrage opportunities between Hyperliquid and Binance. You can go long on ETH perpetual contracts on Binance while shorting ETH perpetual contracts on Hyperliquid, resulting in a difference in annualized yield of 59.3% and 31.2%, or 28.1%. However, this strategy also carries some risks:
Fluctuations in the funding rate may lead to long funding fees on Binance being higher than short funding fees on Hyperliquid, resulting in losses.
Because long positions are not spot, you cannot earn staking rewards, which reduces overall returns.
But the advantage of this method is that when using perpetual contracts for long and short operations, you can utilize leverage, thereby improving capital efficiency. It is recommended to create an Excel spreadsheet to compare the returns and risks of different strategies and find the one that suits you best.
When the funding rate is positive (as shown in our example), long traders need to pay funding fees, while short traders will receive funding fees. This is crucial because it provides the basis for designing a delta-neutral strategy to profit from the funding rate.
Cash and Carry Trade
One of the simplest and most common strategies is "Cash and Carry Trade," which involves simultaneously buying spot assets and selling the same amount of perpetual contracts. For example, the trading strategy for ETH is as follows:
Buy 10 ETH/stETH spot (worth $37,000)
Sell 10 ETH perpetual contracts (worth $37,000, can be executed on dYdX, Hyperliquid, Binance, or Bybit)
At the time of writing this article, ETH's trading price is approximately $3,700. To execute this strategy, traders should aim to complete buying and selling operations simultaneously at the same price and quantity to avoid "unbalanced risk" (i.e., market fluctuations causing both sides' positions to be unable to hedge completely).
The goal of this strategy is to earn an annualized yield of 59% through the funding rate regardless of whether the market price rises or falls. However, while this yield looks very appealing, traders need to be aware that the funding rates may vary across different exchanges and assets, which will affect the final returns.
Your daily funding fee income can be calculated using the following formula:
Funding fee income = Position value x Funding rate
Taking the current ETH funding rate of 0.0321% as an example, we calculate the daily income:
Daily funding fee income: 10 ETH x 3,700 = $37,000 x 0.0540% = $20, settled 3 times a day, totaling $60.
Daily staking income: 10 ETH x 1.036 = 0.36 ETH per year / 365 = 0.001 ETH per day, equivalent to $3,700 x 0.001 ETH = $3.7.
Therefore, the total daily income is $60 + $3.7 = $63.7. For some people, this might be a decent income, while for others, it may seem insignificant.
However, this strategy also faces some risks and challenges:
The difficulty of opening long/short positions simultaneously: If you check the spot price of ETH and the perpetual contract price on Binance or Bybit, you will find that there is usually a price difference between the two.
For instance, when I wrote this article, the spot price was $3,852, while the perpetual contract price was $3,861, with a price difference of $9.
What should you do? Try with a small amount of capital, and you will find it almost impossible to perfectly match long and short positions.
Should you go long first and wait for the price to rise before going short, or go short first and wait for the spot price to fall before buying? Or should you balance long and short positions by building positions in batches (DCA, which means gradually buying or selling in phases)?
Trading fees: Opening and closing positions incur fees. If your holding time is less than 24 hours, the fees may cause you to incur losses.
Low capital rebalancing risk: If your long and short positions are equal but the market fluctuates significantly (for example, ETH doubles to $7,600), the short position may incur deep losses while the long position gains significantly. This may lead to an imbalance in your account's net value and even force liquidation.
Liquidation risk: Depending on the available funds in your account at the exchange, if a short position encounters extreme market conditions (for example, ETH price surges), liquidation may be triggered.
Funding rate fluctuations: The funding rate fluctuates with market changes, which may directly affect your income.
The difficulty of closing positions simultaneously: The challenges faced when closing positions are similar to those when opening positions, and it may not be possible to accurately match long and short positions, leading to extra costs or risks.
Centralized exchange risk: If Binance or Bybit experiences issues, such as bankruptcy or withdrawal restrictions, your funds may be at risk of loss. This is similar to the risks associated with smart contract vulnerabilities in DeFi.
Operational error risk: If you are not familiar with perpetual contracts, you need to be especially cautious. Mistakes with market orders can lead to extreme price fluctuations, and you may execute trades at very poor prices. Additionally, opening or closing a position requires just a click of a button, and operational errors may significantly undermine trading results.
By the way, you can also explore options trading. This method may be simpler and can save you some costs :)
I just want to show you how to try Ethena Labs' trading strategy.
That’s all for today’s content.
We see the order book, anonymous friend.
