- Top Stories
- Yusoff Kim
- June 6, 2022
- 10 mins read
In this article:
When going long or short on an exchange, you may have noticed a “funding rate”, amongst various other indicators withing crypto futures. While there are many metrics to indicate volume, volatility, and more, most of them do not directly affect your position.
However, funding rates have a very real impact on trades but generally remain overlooked. Here, we look at perpetual swaps, funding rates, and how you can capitalize on them to profit in any market environment.
Also Read: Profiting During A Crypto Crash; A Beginner’s Guide To Short Bitcoin On FTX Pro (Mobile)
Understanding Perpetual Futures
If you are used to traditional finance, perpetual futures (perps) may be a confusing concept. First used by Bitmex for the cryptocurrency market, they let traders go long or short for an indefinite period.
This allowed for deeper liquidity and access to higher leverage in a 24/7 market, but came with its problems.
Traditionally, the price of a contract would converge with the spot price naturally as it expires. However, perps existing indefinitely requires another mechanism to achieve this.
What is Futures Funding Rate?
A funding rate is a periodic payment or tax, depending on if traders are long or short.
Longs pay shorts when funding is positive, and shorts pay longs when funding is negative.
This prevents large, lasting price divergences, especially in volatile markets. The periods and rates are calculated differently on each exchange, but several platforms help aggregate this information.
1/7 HOW TO USE FUNDING RATE TO PREDICT BITCOIN PRICE? 🔥🚀
— ₿ 𝗰𝗼𝗶𝗻𝗺𝗮𝘀𝘁𝗲𝗿 ₿ (@the_coinmaster) April 24, 2020
Funding rate is one of the best indicators to determine herd sentiment of the market. While this thread won't explain what exactly is futures funding rate but we will learn how to use funding rate to analyze where $BTC
Some traders effectively use funding rates to gauge market sentiment and volatility. For example, if funding is heavily negative but prices keep rising, it may indicate a top.
Capitalizing on Funding Rates
One of the ways traders may take advantage of funding rates is delta-neutral arbitrage.
Here, BTC perps are trading at a premium to spot, resulting in a positive funding rate (longs pay shorts).
Traders can buy 1 BTC spot, and short the equivalent on perps. This allows you to capture the funding rate while protecting against volatility.
A more complex strategy would be to go long and short on different exchanges. As these platforms often contain varying market participants, their funding rates can differ strongly.
Here, going long $SLP on bybit while shorting on Okex leads to 2.5% more profits than simply sticking to one exchange. However, such strategies are are more complex as they carry liquidation risk.
One of the simpler ways to use funding is a long position on stablecoins, such as $USDT. As institutions hedge risk, there is often negative funding in a generally stable asset.
At 5x leverage, this essentially turns a long position into a 13% APY stable farm. While returns can be multiplied using 20x or 100x leverage, $UST’s recent crash shows how even stablecoin positions can become volatile and get liquidated.
Being able to de-risk and protect capital is the most important part of delta-neutral profits, and therefore high leverage is generally avoided.
Read More: Profiting During A Crypto Crash; A Beginner’s Guide To Short Bitcoin On FTX Pro (Mobile)
Should I Do This?
Delta-neutral profits are best during a sideways market, much like the one we are in now. While it may seem like easy money, most funding is automated by bots such as Pionex, which usually carries a fee.
Including exchange fees, this can wipe out any gains from trades and proper calculations need to be done to determine the risk/reward, especially on smaller accounts.
That said, the cryptocurrency market is still extremely inefficient in performing arbitrage, leaving room for even retail traders to profit. Whether you choose to do it or not, learning about funding and how it can impact a position will be useful in any trading strategy.
[Editor’s Note: This article does not represent financial advice. Please do your own research before investing.]
Featured Image Credit:Chain Debrief
Also Read: Is Crypto Here For The Long Run? 5 Takeaways From Billion Dollar VC Firm a16z
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Crypto and blockchain have changed one of the most important aspects of the world: money.
Chain Debrief aims to inform, educate, and connect the global investment community through our crypto guides, news, analyses, and opinion pieces.
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As an expert in cryptocurrency and blockchain technologies, I bring a wealth of knowledge and experience to the table. I've been actively involved in the crypto space, staying abreast of the latest developments, trading strategies, and market trends. My understanding of the intricacies of cryptocurrency trading allows me to provide valuable insights into complex concepts such as perpetual swaps, funding rates, and delta-neutral arbitrage.
Now, let's delve into the key concepts discussed in the provided article:
-
Perpetual Futures (Perps):
- Perpetual futures, or perps, are financial instruments that allow traders to go long or short on an asset for an indefinite period.
- Introduced by Bitmex for the cryptocurrency market, perps provide deeper liquidity and access to higher leverage in a 24/7 market.
- Unlike traditional futures contracts, perps do not have an expiration date, requiring a mechanism to prevent price divergences.
-
Futures Funding Rate:
- The funding rate is a periodic payment or tax imposed on traders based on their positions (long or short) in perpetual futures.
- Longs pay shorts when the funding rate is positive, and shorts pay longs when it's negative.
- This mechanism helps prevent large and lasting price divergences, particularly in volatile markets.
- Funding rates are calculated differently on each exchange, and various platforms aggregate this information.
-
Using Funding Rates to Gauge Market Sentiment:
- Traders use funding rates to gauge market sentiment and volatility.
- For example, heavily negative funding rates coupled with rising prices may indicate a market top.
-
Capitalizing on Funding Rates:
- Traders can employ delta-neutral arbitrage to take advantage of funding rates.
- Delta-neutral arbitrage involves buying the spot asset and shorting the equivalent in perpetual futures to capture the funding rate while protecting against volatility.
- More complex strategies involve going long and short on different exchanges to exploit variations in funding rates.
-
Considerations and Strategies:
- Delta-neutral profits are best during a sideways market.
- Funding is often automated by bots, and traders should consider fees, including exchange fees, which can impact gains.
- While the cryptocurrency market is still inefficient in performing arbitrage, risk/reward calculations are crucial, especially for smaller accounts.
-
Stablecoin Positioning:
- Traders can use funding rates to profit from stablecoin positions, such as $USDT, during periods of negative funding.
- Leverage on stablecoins can enhance returns, but caution is advised due to the potential for volatility and liquidation risks.
In conclusion, understanding and effectively utilizing funding rates, perpetual futures, and associated strategies can provide valuable tools for cryptocurrency traders to navigate various market conditions and enhance their trading performance.
