In this post I’ll explore how many “investors” are making double and sometimes triple digit returns with zero downside risk instead of lending. This type of play is not going to get you rich overnight, but the returns can be still stellar – up to 100% APR – compared to traditional finance returns – and they’re super easy to setup too.
Zero risk, really? Pretty much, or as low as possible in the crypto world, and no worse (if not better) than most traditional finance products. This system is based on FTX.com, so if you don’t have an account yet – sign-up now using this link for 5% off your trading fees.
When you’re set, let’s have a look at an example perp contract, let’s go with SOL – https://ftx.com/trade/SOL-PERP – now take a look at the field in the top right corner of the trading window called Predicted Funding Rate. Here’s the value at the time of drafting this post:
It’s showing as 0.0013%. Now hover your mouse over the text Predicted Funding Rate – a popup shows the following text:
…Longs pay shorts if positive, shorts pay longs if negative. 1/24 times the average premium over the hour.
Let me explain what this all means. The funding rate is like an interest rate. It is the hourly rate people pay to use leverage to long or short this perp. So if you decide to go long on SOL with 5X leverage, you will pay this much interest every hour to borrow the funds needed to use that leverage. It’s an hourly rate, so for this particular rate that works out to 0.0312% per day, or 11.388% per year, or APR. So who gets this interest payment? Well, it does say “…Longs pay shorts if positive” – so basically if I were holding SOL as a short while you were holding it long, you would be paying me that interest. If the number was negative, I (being short) would be paying you (being long) the rate shown.
Keep in mind this value changes often, and depends on many factors – here’s the hourly change/history at the time of the screenshot above:
Generally speaking, stronger trends pay more (this is also a good sentiment indicator – if the rate is high, but price hasn’t moved much, it may mean an upside move is imminent – but that’s a totally different post!). So how do we use this to our advantage? We definitely don’t want to be shorting SOL for 10 or 20% APR when everyone else seems to be going long – that’s a bad move! What we’re interested in is earning that interest without worrying about the price movement. If we can remove the price movement risk while still earning the interest, then we’ve removed any downside (or upside) movement and our funds grow at the interest rate shown – plus we get paid out hourly!
How to Remove Downside Risk
We do this with hedging. In a nutshell, we go both long and short at the same time. This removes the directional risk – ie no downside risk, while still earning the funding rate on our short. However, for the long we buy spot instead of the perp. The prices are extremely closely correlated, so there’s virtually no difference. As the price fluctuates, our total investment remains the same, while earning the funding payment on our short. Here’s how to set this up.
- Find the perp you want to go short on – more on that later. Make sure there’s an equivalent spot pair for the same perp – not all perps on FTX have equivalent spot pairs.
- Using half of your funds, go long on the spot version of your pair – eg SOL-USD.
- Using the other half of your funds, go short on the perp, eg SOL-PERP – the spot buy is used as collateral for your short perp.
That’s it! Now a few tips to keep in mind:
- NEVER use leverage on your perps for this setup. This system is designed to eliminate the downside risk. If you use leverage, you could get liquidated – losing a significant portion of your funds, and completely against what this is designed to do.
- When making your buys/sells, try going with limit trades to get your orders on the books – ie. don’t set a price that forces the trade right away. This will ensure you only pay maker fees instead of taker fees – these are not significant by any means on ftx, eg 0.07% vs 0.02%, but they can add up – especially if you’re compounding hourly.
- Keep an eye on the funding rate. Dont panic if it goes negative, it happens – but if it stays negative for a while, or price action seems to indicate a longer term downward price movement, you may want to close your positions until things pick up again.
- Since half your funds are being used for the hedge, you’re only earning that funding rate on the funds in your short – effectively halving your return. This might not seem so attractive with SOL paying out 12% to 24% per year (6% to 12% effective) – but there’s many others paying much more – I’ve seen rates over 200% APR quite often.
- You can stay in the position as long as it’s paying a reasonable amount. Don’t jump in and out too often since you need to be in the play long enough to cover your buy and sell fees for both your spot and perp trades.
- Don’t forget to compound and maintain your hedge balance. You’ll be able to see your funding payments in your account balance. A 50% APR compounded daily works out to 64.82% APY, hourly it’s 64.87%…. so don’t beat yourself up if you’re not able to compound hourly.
How to Find the Best Funding Rates of FTX
There’s an easy way to find out the best funding rates so you know which tokens or coins to go with. This is at ftxpremiums.com. The first table shows all the stats you need to make a choice on what perp (or perps) to go with. I generally tend to sort by the 3 or 7 day column, then filter out the volume to a reasonable number, say at least $1m. I also keep an eye on the longer time frame columns – if these are negative, I generally won’t look at them.
When you’ve found the ones you want to play, make sure there’s a spot equivalent on FTX so you’re not wasting your time. Then, and this is optional, scroll down a bit further on the page to the Funding Charts section and pull up your perp to get a better idea of the long term funding fluctuations. Here’s the chart for SOL, since I started with that – you can see over the last six months we’ve sneaked into negative territory, hit up to 40%, and average around 20% during this period.
If you want, have a look at the last year for SOL, you’ll see when the fluctuations in funding were much higher when the market was hot, and not – ie +/- 200% in some cases.
Bonus Tip for Maximizing Returns
I’ve tried this system a few times and it works great, though I’m usually in for the riskier plays with higher upside (and downsides). So one thought I had on how to play this particular strategy, but to maximize returns would be to possibly go with some margin on your spot long.
Basically, you would use (about) 90% of your funds on the short, then (in another sub-account maybe) go long on margin at (about) 10x. (The values would work out to 9.09% on your spot with 10x margin, and the remaining 90.91% on your short – never use leverage on your perp!!).
The interest you pay on the margin would be a USD borrow rate and would typically be much lower than the funding rate on the short – and you earn the difference. So instead of earning half on say a 50% APR funding rate (using a 50/50 play) – you would earn something closer to say 40% – depending on the borrow rate (ie 50% x 90% of your funds, minus the borrow rate, say 5% = ~40%).
You may need some collateral in your account to cover the margin side, but I think FTX allows you to do that easily using any of your other holdings – like staked FTT for example.
That’s pretty much it. I’ve had thoughts of writing a python script to automate this, but it’s not high on my list at the moment.
In Part two I’ll give another zero risk option that could pay out a fair bit more – it’s slightly more complex to setup and maintain – but well worth it in my opinion. Don’t miss part two! Sign up below (if you haven’t already) to get a notification to your email inbox when it’s published.
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