Funding Rate Arbitrage

What is Funding Rate Arbitrage?

Funding rate arbitrage is a trading strategy that exploits differences in funding rates between various markets. The key to this strategy lies in maintaining a delta-neutral position, meaning your overall exposure to price movements is balanced.

In simpler terms, you aim to offset any gains or losses from price fluctuations with profits earned from funding rates. There is more than one type of Funding Rate Arbitrage but we will focus on the following, since this is the main strategy of BounceBit.

Spot — Perpetual Arbitrage

This strategy involves executing two opposing trades simultaneously, with equal quantities, in both spot and perpetual contracts. Its goal is to capture the funding fee income from perpetual contract trading.

Positive Arbitrage: When the funding rate is positive, buying spot and shorting an equivalent position in perpetual contracts generates stable funding fee income.
Negative Arbitrage: When the funding rate is negative, selling borrowed coins on spot with leverage and going long in perpetual contracts with an equivalent leveraged position earns stable funding fee income.

For example: BTC is priced at $20,000 USDT and the funding rate is 0.03%. Let’s explore funding rate arbitrage using $4,000 USDT with 1x leverage:

Buy $2,000 USDT worth of BTC spot and short $2,000 USDT worth of a BTC perpetual contract.
Assuming consistent funding rates, every 8 hours, you would receive $2,000 USDT * 0.03% = $0.60 USDT.
Collecting $0.60 USDT every 8 hours translates to $1.80 USDT per day. With an annualized return calculation, this translates to 1.80 * 365 / 2,000 = 32.95%.

Benefits of Funding Rate Arbitrage

There are several reasons why funding rate arbitrage is attracting attention, especially within the digital asset space:

Reduced Risk Portfolio: Unlike high-risk strategies like leveraged futures, funding rate arbitrage focuses on exploiting price discrepancies between platforms for the same asset, not predicting market direction. This reduces reliance on price forecasts, leading to a lower overall risk portfolio.
Market Inefficiency Opportunities: The strategy capitalizes on temporary misalignments in funding rates. By exploiting these short-term inefficiencies, arbitrageurs can capture additional returns not available through traditional trading.
Market Neutrality: Funding rate arbitrage is market-neutral, meaning it works in bullish, bearish, or sideways markets. The focus lies on the differential between funding rates, not the overall price trajectory. This flexibility allows for participation regardless of the broader market trend.

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Last updated 1 year ago

What is Funding Rate Arbitrage?

Spot — Perpetual Arbitrage

Positive Arbitrage: When the funding rate is positive, buying spot and shorting an equivalent position in perpetual contracts generates stable funding fee income.

Negative Arbitrage: When the funding rate is negative, selling borrowed coins on spot with leverage and going long in perpetual contracts with an equivalent leveraged position earns stable funding fee income.

For example: BTC is priced at $20,000 USDT and the funding rate is 0.03%. Let’s explore funding rate arbitrage using $4,000 USDT with 1x leverage:

Buy $2,000 USDT worth of BTC spot and short $2,000 USDT worth of a BTC perpetual contract.

Assuming consistent funding rates, every 8 hours, you would receive $2,000 USDT * 0.03% = $0.60 USDT.

Collecting $0.60 USDT every 8 hours translates to $1.80 USDT per day. With an annualized return calculation, this translates to 1.80 * 365 / 2,000 = 32.95%.

Benefits of Funding Rate Arbitrage

There are several reasons why funding rate arbitrage is attracting attention, especially within the digital asset space:

Reduced Risk Portfolio: Unlike high-risk strategies like leveraged futures, funding rate arbitrage focuses on exploiting price discrepancies between platforms for the same asset, not predicting market direction. This reduces reliance on price forecasts, leading to a lower overall risk portfolio.

Market Inefficiency Opportunities: The strategy capitalizes on temporary misalignments in funding rates. By exploiting these short-term inefficiencies, arbitrageurs can capture additional returns not available through traditional trading.

Market Neutrality: Funding rate arbitrage is market-neutral, meaning it works in bullish, bearish, or sideways markets. The focus lies on the differential between funding rates, not the overall price trajectory. This flexibility allows for participation regardless of the broader market trend.