♨️Arbitrage

Arbitrage refers to the practice of purchasing an asset in one market and concurrently selling it in another market at a higher price.

Arbitraging in traditional finance

Arbitrage, a cornerstone concept in traditional finance, offers investors a strategic avenue to harness profit from market inefficiencies, while taking minimal risk. At its core, arbitrage involves the simultaneous buying and selling of assets in different markets to exploit price differentials. This practice capitalizes on the inherent tendency of markets to temporarily mispriced assets, providing astute traders with the opportunity to secure gains.

Funding rate arbitrage (basis trade)

Funding rate arbitrage is a strategy commonly employed in cryptocurrency derivatives trading, particularly in perpetual futures contracts. These contracts are designed to track the price of the underlying asset but do not have an expiration date. Instead, they use a mechanism called the funding rate to ensure the contract price closely mirrors the spot price of the asset.

The funding rate is a mechanism used to maintain balance between the perpetual futures market and the spot market. It is periodically exchanged between long and short traders based on the difference between the contract price and the spot price. When the contract price is trading above the spot price, long traders pay short traders a funding rate, and vice versa.

Funding rate arbitrage involves taking corresponding long and short positions to take advantage of funding rate discrepancies in different trading venues, both on-chain on DEXs and CEXs.