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Lols, many people that attend conferences and jot vital points barely open the notes forever. I know you are among them.
Arbitrage is simply the price difference between goods and services in different markets.
If you have milked Naira to Dollar arbitrage before, this is a familiar term.
For instance, if coke is selling at $1 in Lagos, but consumers are buying at the rate of $5/bottle in London, that’s an arbitrage opportunity for traders. Buy from the Lagos market and sell in London.
The funding rate is the interest that is paid in the futures market. It is either positive or negative.
The reason why funding fee is paid is that spot and futures markets often have price differences. Crypto exchanges use the funding to maintain balance. Usually, this helped in closing this gap after a while.
It means that the price gap cannot exist forever. Do you understand?
In the image above, LITUSDT was trading at $0.86 on the spot market and $0.77 on the futures market, this provided an arbitrage opportunity. But in this article, I prefer to use Bitcoin as an example because everyone is familiar with it.
When Bitcoin is trading at $22k on the spot market but is trading at $21k in the futures market.
This is an arbitrage opportunity. There will be a negative funding rate as you can see in the screenshot of the LIT coin.
For negative funding, short will pay long. Got it?
If Bitcoin is trading at $20k in the spot market, and it is trading at $22k in the futures market.
The funding fee will be positive. It could be 3% per 8 hours until the price gap is filled.
So you can see that funding rate or funding fee is a fancy name for arbitrage opportunity, but you don’t know until this morning. I deserve 50 claps from you right now 🙂
I can see what you are thinking. You are like Abimbola, please stop wasting my time here, just go straight to where money is. What I am after is money, not the story
Dear friend, please be patient, let me explain crypto futures arbitrage trading from the first principle.
Don’t blame me, this is how I was taught in engineering school.
For a negative funding rate, it is dicey. Except you are a pro trader, I won’t advise you to take advantage of it.
If you try it, the market may nuke you right away.
The fact that people may have contrary opinions doesn’t mean that I should not warn you. You can make money from negative funding, but be very careful.
For a positive funding rate, even a high school kid can make money from it.
Wait, let me explain with a practical example.
When long is paying short, it means that Bitcoin is cheaper in the spot market but expensive in the futures market.
What are you supposed to do when you see this opportunity on Binance or any crypto exchange?
Assuming that you want to trade the arbitrage with $20k.
You will go to the spot market and buy Bitcoin with $15k of the money. Then you quickly go to futures and short Bitcoin with the remaining $5k using 3x leverage.
It means that you have $15k worth of Bitcoin in your spot wallet and a $15k Bitcoin contract on futures. The equation is now balanced, so there is no fear of losing money because both are properly hedged at the same time.
Now that both positions are properly hedged.
Since long will pay short, you have an open short position on the futures market.
You will be earning 3% interest for keeping that short position every 8 hours depending on the exchange where you are trading.
If this arbitrage should continue for 24 hours, you could get 9% extra money on your short position.
In some cases, the arbitrage could last for 3 days, especially for altcoins with less than $100m market capitalization.
Let’s say you finally got 12% interest before the price gap is closed.
As soon as the gap is closed, go to the spot market and sell your Bitcoin, and close your short position on the futures market.
You need to keep an eye on the markets and don’t go on a short holiday while you are doing this.
Since you have earned 12% of $5k on the futures market,
You have successfully increased your money by an extra $600 through this arbitrage opportunity.
If you do this twice a month with the same result, that’s $1200 extra money. I hope you understand this. If you have any questions ask me in the comment box.