Arbitraging in Perpetual Futures
Last updated
Last updated
Horizon Protocol is a DeFi platform for perpetual futures with low fees and up to 50x of leverage. Traders can already trade perpetual futures in an ever-growing list of markets that include Crypto and RWAs!
Aside from traditionally profiting from trading leveraged perpetual futures, there’s another way to earn profit through perpetual futures, and that’s arbitrage. In the following article, we are going to share with you how to earn with an almost risk-free strategy!
Perpetual futures, unlike traditional futures, have no expiry date, and traders can hold their positions indefinitely. With no expiration date, a mechanism called the ‘Funding Rate’ is required to balance out the long and short positions in a futures market as well as keep the futures price inline with its underlying spot price.
The funding rate helps balance the demand between long and short positions by incentivizing positions that improve the balance and disincentivizing positions that worsen it. Positions that improve the market balance are paid over time from the positions that contribute to the imbalance at the funding rate.
This means if there are more people holding a long position vs a short position, longs will have to pay the shorts at the funding rate for holding that position. The funding rate itself is an ever changing percentage that is determined by how skewed a market is to a particular side. A positive funding rate indicates that the market is skewed long, a negative rate means the market is skewed short, and a 0 rate means the market is perfectly balanced.
For more details about funding rates, please refer to our previous article which goes more in-depth into perpetual futures, delta neutrality, and funding rates.
1. Arbitrage within Horizon Protocol
This strategy is what is known as a cash-and-carry trade, where we take advantage of differences between the spot and futures prices. The price difference lies in both the market price and the funding rate.
This strategy is possible completely within Horizon Protocol because both spot and futures exchanges exist in the protocol.
To implement this strategy:
Open a LONG spot position of the market while simultaneously taking on an equivalent-sized SHORT position in the perpetual futures market. By holding these 2 positions, the trader will be perfectly hedged, having no exposure to price fluctuations, only spending on transaction fees and collecting profits from the funding rate in isolation. Note: This cash-and-carry trade is only possible if a perpetual futures market is skewed long and has a positive funding rate.
To calculate how much you make through the funding rate:
Funding Fee = Position Value * Funding Rate
Cash-and-Carry trade example:
Starting capital: $10,000
1-Day Funding Rate for ETHPERP on Horizon Protocol: 0.37248%
Purchase $9,000 worth of spot zETH on Horizon Protocol’s spot exchange
Short ETH on Horizon Protocol futures with $9,000 size ($1,000 capital and 9x leverage)
Trading fees spent: ($9,000 x 0.1% Spot fee = $9) + ($9,000 x 0.015% Futures Fee = $1.35) = $10.35
Earn funding rate payments of $33.52 per day (0.37248% x $9,000 = $33.52)
Total profit if holding the position for 3 days: $90.21 ($33.52 x 3 days - $10.35 fees)
2. Arbitrage between platforms
This strategy is for arbitraging between two perpetual futures platforms with different funding rates. Similar to the above strategy, the goal is to buy opposing positions in two different perpetual futures exchanges and arbitrage the difference in funding rates between them.
This strategy is higher risk because there are two funding rates that you have to keep track of, but can be profitable whether the funding rates are positive OR negative.
To implement this strategy: Open a SHORT position on the exchange with the higher funding rate while simultaneously taking on an equivalent-sized LONG position on the other exchange with the lower funding rate. The trader will have no exposure to price fluctuations and will profit from the difference between the 2 funding rates, after the costs of transaction fees.
Cross-platform funding rate arbitrage example:
Starting capital: $10,000
1-Day funding rate on Platform A: 0.4558%
1-Day funding rate on Platform B: 0.05991%
Short ETH on Platform A with $50,000 size ($5,000 capital x 10x leverage)
Earn a daily funding payment of $227.9 (0.4558% x $50,000) on Platform A
Long ETH on Platform B with $50,000 size ($5,000 capital x 10x leverage)
Pay a daily funding fee of $29.96 (0.05991% x $50,000) on Platform B
Total daily revenue: $197.94 ($227.9 - $29.96)
Trading fees spent: ($50,000 x 0.015% Platform A fee = $7.5) + ($50,000 x 0.03% Platform B Fee = $15) = $22.5
Total profit if holding the position for 3 days: $571.32 ($197.94 x 3 days - $22.5 fees)
Note: This strategy has a notable advantage over the cash-and-carry trade as it can be implemented for profit whether the funding rates are positive OR negative. If the funding rate is negative, the trader can reverse the positions: Open long position on the exchange with the lower funding rate while simultaneously taking on an equivalent-sized SHORT position on the other exchange with the higher funding rate and profit from the funding rate difference.
Risks
A significant consideration when arbitraging funding rates is determining how much leverage to use. Depending on how long you plan to hold the trade and the volatility of the asset, you may opt to lower the leverage used to mitigate the potential scenario of getting liquidated in the futures market. Perpetual futures liquidation incurs additional fees which can potentially cut into your profit. Using more leverage increases the risk of liquidation, but allows you to use less capital on the futures side of the trade. Proper risk management is advised.
Another important consideration is being aware of the funding rates changes If the direction of the funding rate changes from positive to negative or vice versa, then it’s possible that your trade is no longer profitable and could be incurring losses as you are now paying funding rather than receiving it.
Arbitrage is a great way for users who wish to take on less market risk and earn profit in a more reliable way. Arbitrage is also an important part of keeping the ecosystem healthy by keeping market skews balanced and reducing collateral impacts on the protocol’s stakers.
Horizon Protocol offers some of the lowest exchange fees in the market making funding rate arbitrage an even more profitable endeavor. Hope to see you in the markets!
