How to use funding rate for arbitrage?
Understanding the mechanism of funding rate allows for hedging and arbitrage. Compared to mainstream coins like BTC and ETH, altcoins have greater price fluctuations, making them more suitable for funding rate arbitrage.
1. Futures-Spot Arbitrage
Assuming that the reasonable price of DOGE/USDT perpetual contract on WEEX WeiKe Exchange is 0.1 U, the funding rate is 0.1%, and there are 5 minutes left before the next funding settlement. User Xiao Wang opened a short position of 10,000 DOGE/USDT contracts (U-denominated) at a transaction price of 0.1 U. According to the above calculation formula, the value of his position is 10,000 x 0.1 = 1,000 U. At the same time, Xiao Wang bought 10,000 DOGE spot at a price of 0.1 U.
Five minutes later, when it was time to settle the funding fee, the DOGE price had risen to 0.11 U. At this time, in the spot market, Xiao Wang's 10,000 DOGE holdings earned 1,000 U in profit, while in the contract market, his short position of 10,000 DOGE incurred a loss of 1,000 U.
It seems that he broke even, neither making nor losing money, but because Xiao Wang is the short side of the DOGE/USDT perpetual contract and is the party collecting the funding fee, he will receive a funding fee of 10 U (1,000 x 0.1%) paid by the long side. Therefore, without considering the transaction fee, Xiao Wang ultimately made a net profit of 10 U.
In extreme cases, if the funding rate of the DOGE/USDT perpetual contract rises to 1%, Xiao Wang can make a net profit of 100 U within 5 minutes (without considering transaction fees). Extreme increases or decreases in funding rates are not impossible, such as during the FTX crash last year, where the funding rate of the Binance FTT/USDT perpetual contract reached -2.5%, meaning that the long side could receive a funding fee of 2.5% every 2 hours. If the holding value is 10,000 U, they could receive 250 U in 2 hours.
Of course, the above calculations simplified the example and did not take into account the transaction fees. It can be seen that in addition to the level of the funding rate itself, the ability to successfully use funding rate arbitrage also depends on the platform's trading costs. WEEX WeiKe Exchange has previously launched a zero transaction fee promotion for spot trading. If users arbitrage during the promotion, their profits will obviously be greatly amplified.
WEEX Exchange's contract trading fees are also relatively competitive in the industry. According to a report released by rating agency Cryptowisser, the global average contract trading taker fee and maker fee are 0.0591% and 0.0215%, respectively. WEEX Exchange's taker fee rate (0.06%) is very close to the average level, while its maker fee rate (0.02%) is lower than the average.
In addition, WEEX Exchange also launches occasional transaction fee discount coupon activities, which can greatly reduce user trading costs.
2. Cross-platform Arbitrage
Cross-platform arbitrage can also be divided into futures-spot arbitrage, futures-futures arbitrage, and so on.
Futures-spot arbitrage: Taking the operation of Xiao Wang mentioned above as an example, suppose the funding rate of DOGE/USDT perpetual contract on Platform A is higher, at 0.2%, and WEEX exchange is currently offering zero transaction fees for spot trading. Then, Xiao Wang can short DOGE/USDT contract on Platform A and buy the same market value of DOGE spot on WEEX to obtain more funding fee income.
Futures-futures arbitrage: Suppose the funding rate of DOGE/USDT perpetual contract on Platform A is 0.2%, while the funding rate of DOGE/USDT contract on WEEX VIP exchange is 0.1%. Xiao Wang can short on Platform A (to receive more funding fees) and long on WEEX (to pay less funding fees), thus achieving the purpose of arbitrage.
Of course, funding rate arbitrage is not as easy as advertised in the market. Most of the time, due to small market fluctuations, the funding rate itself is not high, and the arbitrage space is limited. In addition, users need to ensure that the value of the long and short positions is the same, and open and close positions at the same time, which is affected by the user's network environment, especially the platform's trading depth. If you encounter a platform with a large difference in depth, the order may not be executed, and the arbitrage may fail, resulting in loss of principal.
WEEX VIP is an exchange known for its trading depth. The platform has established a liquidity center and completed the liquidity 2.0 upgrade in 2022, continuously improving and breaking through its trading depth. It has now become a leader in global exchange liquidity, with order thickness and price spreads better than most contract trading platforms. It is second only to top platforms such as Binance and OKEx, and the top ten bid-ask spread for popular currency pairs have already surpassed its peers, becoming a benchmark in the industry.
To verify its trading depth in practice, WEEX VIP has launched the "Slippage Insurance" campaign, where users can record the price in the screen capture when placing an order, and apply for a price difference subsidy when the ETH price difference is greater than 0.2 U or the BTC price difference is greater than 2 U.
In addition, WEEX VIP provides lightning-fast trading, which allows users to quickly execute trades for arbitrage, keeping the opening and closing prices of both long and short positions consistent, making it more advantageous for hedging arbitrage.
3. Using funding rates to judge overbought and oversold
According to the funding rate mechanism, when the funding rate is relatively high, it means that the market is more frenzied, and the longs need to pay funding fees to the shorts. This causes the number of people willing to go long to decrease because holding long positions requires paying high funding fees. At the same time, the number of people willing to go short increases because holding short positions can earn higher funding fees every day. Even if the market continues to rise, the generous funding fees can partly offset the losses, and the probability of the market turning from rise to fall is relatively high, often indicating that the market has reached a cyclical top.
Conversely, when the funding rate is relatively low, it means that the market is more panic-stricken, and the shorts need to pay funding fees to the longs. This increases the probability of the market turning from fall to rise, and generally speaking, the market has reached a cyclical bottom. This is a relatively good time to buy.
Usually, after prices have risen steadily or fallen rapidly, if the funding rate is negative for three consecutive days, it may mean that the price will not continue to fall.
On the Coinglass platform, when the funding rate is 0.01%, it is displayed in black, representing the benchmark rate. When it is greater than 0.01%, it is displayed in red, representing a bullish market sentiment. When it is less than 0.01%, it is displayed in green, representing a bearish market sentiment. The stronger the bearish or bullish sentiment, the deeper the color.
In July and August of 2020, when Bitcoin prices fluctuated in the range of 11,000 to 12,500 US dollars, the funding rate remained relatively high, and then a small waterfall of over 20% occurred.
During the last bull market cycle, when Bitcoin was fluctuating in the range of 55,000 to 65,000 US dollars, the funding rate also remained high. When the price was approaching the high point of 65,000 US dollars, the funding rate exceeded 0.25%, indicating that the market had reached a frenzy state. Most investors were bullish, and the market often reached its peak at this time, followed by a significant downturn.
Conversely, when the funding rate is relatively low, such as after the small waterfall of Bitcoin from 12,500 US dollars, the funding rate remained in the negative zone, and the panic in the market increased. The number of shorts increased relatively, and the probability of a market reversal increased. At that time, Bitcoin was consolidating around 10,000 US dollars for two months, and then it started the main bullish wave of the bull market.
Funding rate is a mechanism used by exchanges to regulate the mutual payment exchange of costs between long and short positions. Its purpose is to maintain the price difference between the perpetual contract market and the spot market in a balanced state, thus returning the price to a normal level. Objectively, it also serves to limit malicious manipulation of contract prices.
Based on the operating mechanism of funding rates, traders can use them for arbitrage and market analysis.
If you are keen to become a WEEX Partner, do reach out to our Head of Global Expansion at [email protected]
Connect With the Community Here:
Discord | Facebook | Twitter | Telegram
Official Website: https://weex.com/en/