What’s Spot-Futures Arbitrage Bot?

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Arbitrage Opportunities in the Volatile Crypto Market

The highly volatile market in cryptocurrency gives most investors a high-risk and high-return investment impression. It’s normal to see a coin surge up to 20% and then head to a 20% correction on the next day. In addition to the spot market, lots of exchanges also offer perpetual futures contracts that allow traders to use up to 125x leverage, making the cryptocurrency market even more volatile.

On the other hand, the inefficiencies between each market give us plenty of opportunities to arbitrage. It’s easy to reach 350%~400% APR with arbitrage strategies, and I’m going to show you how to arbitrage from these inefficiencies.

What is Perpetual Futures Contracts?

Unlike traditional futures, perpetual futures contracts don’t have an expiration date, so that traders can trade perpetual futures just like spot trading. That’s one of the main reason perpetual futures contracts is so popular in the crypto community.

Typically, traditional futures contracts settle on a monthly or quarterly basis. At settlement, the contract price converges with the spot price, and all open positions expire.

Since perpetual futures contracts never settle in the traditional sense, exchanges need a mechanism to ensure that futures prices and index prices converge on a regular basis. This mechanism is also known as Funding Rate.

The funding rate plays an essential role in the arbitrage opportunity that we’re going to discuss in the next section.

What is the Funding Rate

The funding rate ensures that futures prices and index prices converge regularly.

So when a perpetual futures contract is trading on a premium (higher than the spot markets), long positions have to pay shorts due to a positive funding rate. In contrast, short positions pay longs while the futures price is trading below the index price.

The Index Price consists of the average price of an asset, according to major spot markets and their relative trading volume.

The exchanges do not charge the funding fee. It’s paid peer-to-peer.

Most of the investors in the crypto market like to hold a long position rather than a short position, which means traders with long positions need to pay funding rates to those who have a short position.

So here’s the arbitrage opportunity. We can hold a short position in the perpetual futures market and buy the same amount in the spot market, hedging our total investment. Our investment won’t be affected by the market fluctuation due to the market-neutral position but receive funding rates with our short position in the perpetual futures contracts.

Spot-Futures Arbitrage

To sum up, hold a short position in the perpetual futures market while holding the same amount of position in the spot market. Arbitrage with a market-neutral position and receive the funding rate every 24 hours.

The funding rate comprises two components: the interest rate and the premium. The interest rate fixed at 1% per 24 hours, and the premium varies according to the price difference between the perpetual contract and mark price.

According to the historical data of the ETH funding rate on Binance, the rate has always been positive in the last 12 months. And it’s higher when the price surge in the following chart. If we can receive a 1% funding rate per day, the performance for this arbitrage would be 360.5% APR!

With the historical data, it’s steady and almost risk-free to arbitrage from the funding rate.

 

 

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