As a kind of risk-free income, funding rate arbitrage has attracted more and more attention, especially in the bull market, when extremely high funding fees are simply a money-making killer. This article, based on my actual experience, will tell you how to practice funding rate arbitrage.
1. What is the Funding Rate?
In order to keep the perpetual contract price consistent with the spot price, taking Binance as an example, it is generally settled every 8 hours or 4 hours. The 0.01% in the above figure is the current funding rate, which is converted into an annualized return of 0.01%*3*365=10.95%, that is, you can receive 10.95% of the position value in funding fees in one year.
Perpetual Price > Spot Price: The funding rate is positive, indicating that more capital is being allocated to long contracts. At this point, longs need to pay funding fees to shorts, compelling longs to close their positions and forcing contract prices to drop closer to spot prices. This typically occurs during market frenzy in bull markets.
Perpetual Price < Spot Price: The funding rate is negative, indicating that more capital is being allocated to short contracts. At this point, shorts need to pay funding fees to longs, compelling shorts to close their positions and forcing contract prices to rise closer to spot prices. This typically occurs during market panic in bear markets.
2. Arbitrage Principle
Having understood the logic of funding rates, the next step is to target specific arbitrage opportunities.
Positive Funding Rate: Buy spot and open short contracts, which is known as 'hedging.' It is important that they are of equal value; for example, if you buy 1 BTC in spot, the short position in the contract should also be 1 BTC, ensuring that regardless of price fluctuations, the total value of your positions remains unchanged, thus earning funding income. In actual operations, you can choose to arbitrage based on higher positive funding rates to obtain greater funding income.
Generally, in a market frenzy bull market, there are many people using leverage to go long, and funding rates are generally high, making it a good time for arbitrage. Alternatively, strong bullish sentiment in certain cryptocurrencies can also lead to higher funding rates. Recently, the funding rates for MOODENG have been high, and I opened a position. Based on this yield calculation for MOODENG, the maximum daily income could be 31*6=186 USDT. However, actual income will be slightly lower due to fluctuations in funding rates, and maintaining high rates is difficult, necessitating periodic switching of cryptocurrencies.
Negative Funding Rate: Sell the spot and buy contracts. If you do not plan to hold the spot long-term, you can only borrow coins in the leverage market. Since negative funding situations are rare, beginners can temporarily disregard this part; we mainly focus on situations with positive funding.
3. Practical Operation and Precautions
Understood the logic, next are the actual operation steps, using Binance as an example.
First, you need to have USDT ready in both your spot account and contract account. The funds in the spot account are used to buy spot assets, while the funds in the contract account are used as margin for shorting. For every amount of spot purchased, you should simultaneously short the equivalent amount of contracts to hedge your positions and wait to receive funding fees. If you're not familiar with contracts, you need to understand a few parameters:
Cross Margin or Isolated Margin: Cross Margin uses all USDT in the contract account as margin, which is more capital efficient, but positions are harder to manage; if liquidation occurs, all positions will be affected. Isolated Margin allows each position to have separate margin, with each position and margin being independent.
Joint Margin Model: Assets like BTC and ETH can also be used as margin to further enhance capital efficiency. However, ensure that there is USDT in the contract account; otherwise, funds like BTC will be converted to USDT.
It is recommended to enable cross margin mode and joint margin mode.
Access preferences by clicking the three dots in the upper right corner of the contract interface to make changes.
4. Techniques
1. Position Management: The risk of arbitrage is the liquidation of contract positions. Fortunately, we can see the estimated liquidation price, and we try to keep the price above 2-3 times the current price. Additionally, the value of positions in different cryptocurrencies should ideally be similar, especially when arbitraging altcoins and opening multiple positions, making management easier. Furthermore, we can set price alerts; in Binance's K-line interface, there is a price alert function in the lower left corner to set a reminder price to timely add margin.
2. Increase Capital Efficiency: The purchased spot assets, like BTC and ETH, can be transferred into contracts as margin, while altcoins can be placed into a liquid investment account or used as margin for leverage, borrowing USDT to increase arbitrage leverage.
3. Price Difference Income: When the funding rate is positive, since contract prices > spot prices, shorting and buying spot will yield a certain price difference income, especially when some altcoins have outrageously high funding fees. However, many spot assets are not listed on Binance, so you may need to buy the spot on other exchanges or DEXs to complete the hedge, which can be identified through coingecko to find where you can trade spot.
4. Information Source: In Binance's contract data, there is an 'Arbitrage Data' section where the current funding income situation can be viewed. Alternatively, on coinglass.com in the 'Funding Rate' section, you can also check the funding rates for various cryptocurrencies, making it easier to choose which cryptocurrencies to arbitrage.
5. Fees: Binance's contract order fees are lower than market-taking fees, and BNB can be used to offset fees. Since arbitrage involves frequent position switching (closing positions with low funding rates and opening positions with high funding rates), it is recommended to open a rebate account specifically for arbitrage, and I will return 35% of the fees to you. For specifics, you can refer to (How outrageous are trading fees?) for this content.
Due to the design of funding rates, the baseline funding rate for all cryptocurrencies is 0.01%/8h, which means, not considering friction costs, it can yield about 10% annualized returns year-round. In a bull market, 100%+ annualized returns are not uncommon, making this a good way for us to earn interest on idle USDT. The above is about funding rate arbitrage; if you have any questions, feel free to leave a message, and I will keep updating.
