Perpetual Contract Funding Rate Arbitrage

One-Click Trial: Trading Bots. For trading bots, select “Funding Rate Arbitrage” from the dropdown menu for Perpetual Futures Contracts.

What is a Perpetual Futures Contract?

A Perpetual Futures Contract, particularly in the context of arbitrage involving the funding rate, refers to simultaneously conducting two trades with the same asset, opposite directions, equal quantities, and offsetting profits and losses in both spot and perpetual futures markets. The goal is to profit from the funding rate in perpetual futures trading. Compared to conventional investments, arbitrage between futures and spot markets often yields more stable returns and lower risks. It remains unaffected by price fluctuations, allowing arbitrageurs to secure positive returns regardless of market conditions. Although the risk associated with this type of arbitrage is very low, there is still a possibility of capital loss. Overall, however, it is considered a strategy with a high return on investment ratio.

Let’s explore the concept of funding rate arbitrage in perpetual contracts through text and images.

What is a Perpetual Futures Contract?

Gate.io navigation bar - Derivatives - Perpetual Futures

Perpetual futures contracts on Gate.io, an innovative financial product in the cryptocurrency domain, resemble traditional futures contracts but lack an expiration or settlement date. Traders need only focus on price movements, making it a straightforward and convenient trading instrument. Furthermore, perpetual contracts have had a positive impact on traditional futures trading. The trading of perpetual contracts is based on the index price, which is the asset’s average price calculated from major spot trades and their relative trading volumes. Hence, unlike traditional futures, perpetual contracts often trade at prices equal to or similar to spot trades. However, the mark price may deviate from the spot price under certain circumstances.

What is Perpetual Contract Funding?

By clicking Perpetual Contract Details, you can view basic information about USDT-based or BTC-based contracts, including risk limits, indices, real-time funding rates, and insurance fund history.

Perpetual contracts are a particular type of futures contract. Unlike traditional futures, perpetual contracts do not have an expiration or settlement date. When the price of a perpetual contract deviates from the spot price beyond a reasonable margin, the funding rate mechanism forcibly pulls this price deviation back to a reasonable level. Generally, the greater the market deviation, the higher the funding rate, resulting in better correction effects. Thus, the price of the perpetual contract is adjusted closer to the spot price. The funding rate is an important mechanism for anchoring the perpetual contract price to the spot price, used to balance the sentiment between longs and shorts.

• When the funding rate exceeds 0, long positions pay the funding fee, while short positions receive the funding fee.
• When the funding rate is less than 0, short positions pay the funding fee, while long positions receive it.

The funding fee paid or received = Nominal value of the position * Funding rate

Funding fees are transferred only between users holding long and short positions; the platform does not participate in the distribution of any funding fees. Funding fees are collected every 8 hours, three times daily, with Gate.io settlement times at 00:00, 08:00, and 16:00 UTC. Closing positions before the settlement time means you do not have to pay or cannot receive funding fees.

Explanation of Funding Rate and Funding Fee Calculations

How to Arbitrage Perpetual Contract Funding Fees

Currently, the Gate.io platform supports arbitrage between futures and spot markets under the condition that long positions pay short positions, which is the most stable and common scenario in the market today. By shorting (perpetual) contracts (1X), while holding an equal amount of spot assets, one can balance and hedge between contracts and spot assets to earn the funding rate paid every eight hours. Gate.io calculates the funding rate every minute and takes the average over a period (8 hours) as the final funding rate, which is applied at each funding rate interval (every 8 hours). Funding fees are settled three times daily at UTC: 0:00, 8:00, and 16:00, with the position value determined at these times.

Funding Fee = Position Value * Funding Rate

For calculating position value, refer to the Calculation of Position Value.

Arbitrage involves earning the funding fee settled in perpetual contracts as profit. If only one perpetual contract position is opened, the contract’s losses will likely far exceed the funding fee earnings at settlement. Therefore, making an opposite, equal quantity, and profit-loss offsetting order in the spot market for hedging is necessary.

• If a 1 BTC short order is opened in a perpetual contract, then 1 BTC should be bought in the spot market.
• If the BTC price rises, it means losses in the contract position but profits in the spot position,
• If the BTC price falls, it means profits in the contract position but losses in the spot position,

Through the pricing formula, profit and loss have been balanced, eliminating concerns over the currency’s price fluctuations, and allowing for the collection of perpetual rates peacefully.

When the Funding Rate is Above 0

Currently, the funding rate for the BTC perpetual contract on Gate.io is 0.01%. If the settlement happens now and the estimated funding fee > 0 continues; then, one should short 2 BTC in perpetual contracts while simultaneously buying 2 BTC in the spot market.

At the time of settlement, the funding fee earned from the short position would be 2 * 0.01% = 0.0002 BTC.

Earnings Calculation = Nominal Value of Position * Funding Rate.

When the Funding Rate is Below 0

If the funding rate starts to decrease, even becoming negative, close the positions and exit this arbitrage. If the funding rate is negative, and you hold coins, then the suitable action at this time is to go long in perpetuals and sell the coins. If you do not have spot assets to sell, you can sell through borrowing coins. Reverse arbitrage, selling borrowed coins, involves leveraging various opportunities to maximize the use of capital.

How to Use Gate.io Quantitative Strategy for Perpetual Contract Funding Rate Arbitrage

Click on the Trading Bots, scroll down, and select “Spot-Futures Arbitrage,” which is the perpetual contract funding rate arbitrage. There are 6,272 robots running, with a total investment of $2,728,088.35 and a seven-day annualized yield of 14.39%.

After clicking “Create a Bot,” you fill in the following information:

Glossary

• Leverage: The leverage multiplier for shorting perpetual contracts, with an adjustable range from 1X to 3X.
• Current basis: Current Spot-Futures Price Difference. The price difference between the spot and futures markets. It serves as reference data for placing opening and closing orders.
• Basis control: Spot-Futures Price Difference Control. This refers to using parameters to ensure that the average transaction price of spot and futures trades stays within a certain percentage of the price at order placement. Usually, the value of the current spot-futures price difference is displayed on the page. Users can set a control number for the spot-futures price difference based on this value. This control value generally needs to be lower than the current spot-futures difference to facilitate easier position opening. When the actual price difference deviates significantly from the user-entered value, it triggers an automatic position closing. (Given the crypto market’s high volatility, the actual execution price of contracts often differs from the order price, hence the use of spot-futures price difference control to manage the extent of price movement between spot and futures).

Considerations for Perpetual Contract Funding Rate Arbitrage

Optimal Conditions for Arbitrage

Positive and High Funding Rates: The higher the funding rate, the higher the final funding fee (arbitrage profit) you can earn. This is because the funding fee is calculated as the position value multiplied by the funding rate. A positive seven-day annualized rate is preferable to ensure a probability of profit.

Small Price Difference Between Contracts and Spot: Opt for currencies with minimal contract and spot price differences. When placing orders, select future-spot currency pairs with smaller price differences. This strategy controls the cost of investment. When a price divergence between contracts and spot markets later occurs, you can capitalize on the funding fee generated from the significant basis difference, i.e., the arbitrage profit.

High Position Value: Seek positions with high value, ideally worth tens of millions of dollars, which indicates good market liquidity.

Currencies with Low Transaction Fees: Since each spot purchase or contract short incurs transaction fees, the arbitrage profit is affected by the currency traded and the number of transactions. Therefore, the lower the transaction rate, the higher the net profit for the user.

Basic Risks of Arbitrage

While the spot-futures arbitrage strategy is known for its low-risk profile, it is not entirely without risk. In certain extreme situations, it can result in losses for investors. The main risks include:

• Changes in Funding Rate Direction: Although in the vast majority of cases in the futures market, long positions pay funding fees to short positions, there are instances where short positions pay long positions. In such cases, you would incur interest expenses instead of receiving interest income. The good news is that on Gate.io, the direction of funding rates is very stable, and changes in funding rate direction are rare. Occasional losses caused by changes in funding rates can be compensated for by funding fees received in the next period.
• Liquidation: The spot-futures arbitrage strategy involves establishing positions with perpetual contracts, which entails using leverage. Significant price movements in a currency can lead to the liquidation of your positions. To reduce this risk, Gate.io limits the use of leverage in the spot-futures arbitrage strategy. When opening positions, users can use a maximum of 3x leverage.

Considerations

• The calculation of funding fees does not consider leverage; that is, regardless of the leverage size, it is calculated based on the current position value.
• Gate.io settles funding fees three times daily at UTC 0:00, 8:00, and 16:00. The position value is determined at these times. If a user does not hold a position at these times, they do not participate in the settlement.
• Funding fees balance contract prices through mutual payments between longs and shorts. If the contract market price is much higher than the spot price, the funding rate is positive, and longs pay shorts. Conversely, if the contract market price is much lower than the spot price, the funding rate is negative, and shorts pay longs.
• Funding fees are mutually paid or received between long and short-contract users, not paid to the Gate.io platform. The platform does not take any fees.

Conclusion

Perpetual Contract Funding Rate Arbitrage refers to conducting two simultaneous transactions in spot and perpetual contracts with the same asset, opposite directions, equal quantities, and offsetting profits and losses. The goal is to earn funding rate income in perpetual contract trading. Unlike conventional investments, arbitrage between futures and spot markets offers more stable returns and lower risks. It is unaffected by price fluctuations, allowing for arbitrage opportunities and guaranteed positive returns regardless of market changes. Although the risk of futures-spot arbitrage is very low, there is still a potential for capital loss. However, overall, it remains a high return on investment strategy.

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