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What’s Spot-Futures Arbitrage Bot?

Arbitrage Opportunities in the Volatile Crypto Market

The highly volatile market in cryptocurrency gives most investors a high-risk and high-return investment impression. It’s normal to see a coin surge up to 20% and then head to a 20% correction on the next day. In addition to the spot market, lots of exchanges also offer perpetual futures contracts that allow traders to use up to 125x leverage, making the cryptocurrency market even more volatile.

On the other hand, the inefficiencies between each market give us plenty of opportunities to arbitrage. It’s easy to reach 15%~50% APR with arbitrage strategies, and I’m going to show you how to arbitrage from these inefficiencies.

The results looks amazing huh?

Before talking about how to seize the arbitrage opportunity, let me introduce the fundamental of perpetual futures contracts first.

What is Perpetual Futures Contracts?

Unlike traditional futures, perpetual futures contracts don’t have an expiration date, so that traders can trade perpetual futures just like spot trading. That’s one of the main reason perpetual futures contracts is so popular in the crypto community.

Typically, traditional futures contracts settle on a monthly or quarterly basis. At settlement, the contract price converges with the spot price, and all open positions expire.

Since perpetual futures contracts never settle in the traditional sense, exchanges need a mechanism to ensure that futures prices and index prices converge on a regular basis. This mechanism is also known as Funding Rate.

The funding rate plays an essential role in the arbitrage opportunity that we’re going to discuss in the next section.

What is the Funding Rate

The funding rate ensures that futures prices and index prices converge regularly.

So when a perpetual futures contract is trading on a premium (higher than the spot markets), long positions have to pay shorts due to a positive funding rate. In contrast, short positions pay longs while the futures price is trading below the index price.

The Index Price consists of the average price of an asset, according to major spot markets and their relative trading volume.

The exchanges do not charge the funding fee. It’s paid peer-to-peer.

Most of the investors in the crypto market like to hold a long position rather than a short position, which means traders with long positions need to pay funding rates to those who have a short position.

So here’s the arbitrage opportunity. We can hold a short position in the perpetual futures market and buy the same amount in the spot market, hedging our total investment. Our investment won’t be affected by the market fluctuation due to the market-neutral position but receive funding rates with our short position in the perpetual futures contracts.

Spot-Futures Arbitrage

To sum up, hold a short position in the perpetual futures market while holding the same amount of position in the spot market. Arbitrage with a market-neutral position and receive the funding rate every 8 hours.

The funding rate comprises two components: the interest rate and the premium. The interest rate fixed at 0.01% per 8 hours, and the premium varies according to the price difference between the perpetual contract and mark price.

According to the historical data of the ETH funding rate on Binance, the rate has always been positive in the last 6 months. And it’s higher when the price surge in the following chart. If we can receive a 0.2% funding rate per day, the performance for this arbitrage would be 36.5% APR!

With the historical data, it’s steady and almost risk-free to arbitrage from the funding rate. Next, let’s discuss how to execute the arbitrage by ourselves.

Tutorial for the Spot-Futures Arbitrage

Let’s say we have 10000 USDT for the spot-futures arbitrage while bitcoin’s price is 10000 USDT. Here’s how we’re going to do:

  1. Transfer 5000 USDT to the futures account and the rest 5000 USDT to the trading account.
  2. Buy 0.5 BTC (5000USDT) in the spot market and short 0.5 BTC in the perpetual futures market with your 5000 USDT
  3. If the current funding rate is 0.05% right before the charges, then you’ll get 2.5 USDT.
    0.5 * 10000 * 0.05% = 2.5 USDT
  4. If the funding rate remains at 0.05%, we can receive 3 times a day, which means it’s 27.375% APR
    2.5 * 3 * 365 = 2737.5 USDT
    2737.5 / 10000 * 100% = 27.375%

To increase the annualized return, let’s take advantage of the leverage in the perpetual futures. If we hold the short position with 2x leverage, then we’re able to buy 0.6666 BTC with 6666 USDT while short 0.6666 BTC with 3333 in the perpetual futures market.

We’ll receive 33% more funding fee (3.333 USDT) compared to 1x leverage
0.666 * 10000 * 0.05% = 3.333 USDT

APR under different leverage

The performance increases to 36.46% APR with 2x leverage; 41.0625% APR with 3x leverage!

Besides using higher leverage with your short position and checking the list for a coin with a higher funding rate, the price difference between the futures price and index price should also be considered.

The Price gap between futures and index price.

The price gap is not always a fixed number between futures and index prices. It’ll result in some profit if the gap is lower when you’re about to stop the bot, and suffer from some losses if the gap is higher.

But it’s not that much, which you can cover that loss within 2~3 funding rate income. If you take care of the price gap, you might earn some profit from the price gap.

  • Don’t start arbitrage if the price gap is negative.
  • Finish your arbitrage strategy and close your positions when the gap is lower or negative.
  • Normally, the gap is floating between -1% and 1% most of the time.

Spot-futures arbitrage is a simple strategy that traders could do it manually, but it’s better to use a tool for opening positions and closing positions due to the volatility.

Risks while doing spot-futures arbitrage manually

There’re some risks to perform spot-futures arbitrage manually that you should need to know in advance.

  1. You’re not able to decrease your position in the spot market while the auto-deleveraged happen to your futures position.
  2. The price surge rapidly and you got liquidated on your short position cause you’re not able to close your futures position in advance.

The above two examples show us how would our market-neutral position got broken under particular market conditions. To eliminate the above risks, Pionex provides a bot for spot-futures arbitrage. Here’s how would the bot deal with the potential risks:

  1. The bot will detect both your position in the spot and futures market and maintain a market-neutral position even the auto-deleveraged (ADL) happened.
  2. The bot will close your futures position 5% before the liquidation price. So that you won’t be liquidated and pay for the liquidation fee.

Pionex Spot-Futures Arbitrage Bot

Step 1. Download Pionex App. Scroll down to the bottom of the bot list and click arbitrage bot.

Step 2. Select the target coin and preferred leverage for the arbitrage. Click the drop-down button next to the coin to lead you to the list sorted by the current funding rate.

Step 3. Fill in the investment amount and click create bot. It’ll automatically transfer some of your funds to your futures account and create a position in the spot and futures market.

Step 4. If you want to close the bot, just click the shutdown button on the right top of the bot. It’ll close the position and return all your investment in USDT.

Tips for Spot-Futures Arbitrage

  1. Don’t switch between coins too often. Please remember that you’ll have some trading fee cost when you started and closed the bot.
  2. As long as the funding rate stays positive, keep the bot active for at least 1~2 weeks. But you can still shut it down anytime you want.
  3. One arbitrage bot with one coin at a time. You’re free to top up more investment or take some out anytime.
  4. Don’t put all your eggs in one basket. Arbitrage of 2~3 coins at the same time would be better.
  5. It’s better to start the bot while the price gap is higher; shut down the bot while the price gap is lower or negative.
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