1. Background
Perpetual contracts have a funding rate, and longs and shorts pay each other, mostly 3 times a day. When the funding rate is positive, longs pay shorts, and when the funding rate is negative, shorts pay longs. From the historical funding rate, most of the time it is a positive funding rate. One way to play is to earn funding rates through spot + short contracts. The income obtained is almost risk-free and the APR is good. As the most common arbitrage idea, this gameplay has been scaled and productized. For example, Ethena relies on the perpetual contract funding rate to create USDE, and many CEXs also provide trading tools for funding rate arbitrage.
In daily life, under some extreme market conditions or certain activities, the fees of some coins will soar, and there is a short-term arbitrage space. The recent experiences of FLOKI's Simon Cat Airdrop and GMT's STEPN GO x adidas RaffleMint have caused a large spot-futures price spread and funding rate arbitrage space between FLOKI and GMT.
Let's roughly organize the general logic and ideas of funding rate arbitrage so that we can have a clearer mind when opportunities arise in the future. At the same time, we can see if we can make it into a more automated process later.
2. How to play the funding rate arbitrage
2.1 Positive Funding Rate Arbitrage
Arbitrage idea: Buy spot and open short contract
cost:
1️⃣ Buy spot + subsequent selling fee: 0.1% x 2 (number of transactions) x spot value = 0.2% x spot value.
2️⃣ Opening a short contract + subsequent closing contract fee: 0.05% x 2 (number of transactions) x contract value = 0.1% x contract value.
income:
1️⃣ Funding rate x contract position value x number of times the fee is eaten (high interest rates are generally short-lived, and most of them can only be eaten once).
Another variable here is the spot-futures spread. Generally speaking, when there is an arbitrageable market, the spot-futures spread is often larger, and the spot-futures spread is equal to (spot price-contract price) * the number of coins. In the scenario of positive funding rate arbitrage, the contract price is lower than the spot price, and the spread here is the cost. If the contract price is higher than the spot price, this is part of the profit.
2.2 Negative Funding Rate Arbitrage
Arbitrage idea: borrow coins to sell spot and open long contracts
cost:
1️⃣ Selling spot + subsequent purchase fee: 0.1% x 2 (number of transactions) x spot value = 0.2% x spot value.
2️⃣ Opening long contracts + subsequent closing contract fees: 0.05% x 2 (number of transactions) x contract value = 0.1% x contract value.
3️⃣ Interest on borrowed currency
income:
1️⃣ Funding rate x contract position value x number of times the fee is eaten (high interest rates are generally short-lived, and most of them can only be eaten once).
Another variable here is the spot-futures spread. Generally speaking, when there is an arbitrage market, the spot-futures spread is often larger, and the spot-futures spread is equal to (spot price-contract price) * the number of coins. In the scenario of negative funding rate arbitrage, the contract price is lower than the spot price, and the spread here is part of the profit. If the contract price is higher than the spot price, it is the cost.
Moreover, negative interest rate arbitrage is relatively troublesome, as it requires spot (borrowed currency) to short sell.
3. Some thoughts on arbitrage gameplay
3.1 How is the funding rate calculated?
The funding rates of different exchanges may have slight differences in formula, but there are two main influencing factors: risk-free rate and premium index.
1️⃣ Risk-free rate: Usually set to a fixed value. For example, traders who buy long positions may need to pay a certain interest rate, while traders who sell short positions will receive interest.
2️⃣ Premium Index: The difference between the contract price and the spot price
If you are interested, you can take a lookBinance Funding Rate Calculation Documentation
3.2 Transaction Wear Costs
For this arbitrage, the spot transaction fee of major CEX (DEX is higher) is basically 0.1% (some platforms have platform currency deduction); the contract transaction fee is 0.05% (some platforms will be slightly higher), and the maker order is relatively cheap at 0.02%. As an ordinary user of the exchange, and all orders are taken, the transaction fee for buying and selling is 0.3%. Therefore, if the profit from the spread and funding fee is not high, it may not even be enough to offset the trading wear and tear, and you can only wait for a good opportunity to appear.
Binance's Trading Fees DocumentationBinance’s transaction fee is the lowest among all CEXs, and as the largest exchange, its depth is also very good.
3.3 Arbitrage Opportunities
It is not that you can apply it just by learning the ideas. For example, you may encounter some problems:
Many times, I don’t know that there is such an arbitrage opportunity.
Sometimes when opportunities arise, smart people have a strong information gap. By the time you realize that you want to do negative interest rate arbitrage, the CEX coins may have been borrowed by smart people.
...
If you want to seize the opportunity, the overall idea is probably like this, which needs to be improved:
Monitor hot information (hotspot tracking on Twitter, on-chain data, cex lending/interest rates...). Find the right tools
After discovering the abnormality, you can locate the cause and explore the opportunities. Be familiar enough with the mechanism and gameplay, as well as the related cost and profit accounting.
Execute arbitrage plans. For example, manually inputting prices and quantities is error-prone and troublesome, accessing trading APIs, quickly calculating costs and profits, etc.
