What’s the principle of the arbitrage bot?
The highly volatile market in cryptocurrencies gives most investors a high-risk and high-return investment impression. 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. But first we have to master the key aspects.
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.
When a perpetual futures contract is traded at a higher price than the spot market, long positions have to pay shorts due to a positive funding rate. In contrast, short positions pay longs when the futures price is traded below the index price. The exchanges do not charge the funding fee, it is paid peer-to-peer and every 8 hours.
Spot-Futures Arbitrage Bot takes advantage of that difference. 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 we will receive funding rates regularly with our short position in the perpetual futures contracts.
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