Free Money Funding Rate APR hack: x1 Short on BTC/USD Perpetual

So I've been day tarding trading lately.

I actually made some money the other day shorting the market for the first time ever. Of course by "made money" what I actually mean is the short was up $500 while the rest of my crypto bags bled $10k. These things happen, but it is nice to hedge a little bet during these periods of uncertainty. So far the money I have on the exchanges hasn't lost any value so that's always nice after a sizeable dip.

And then I noticed something

I wasn't making as much money as I thought I should be on the shorts. I also noticed that the value of my collateral was decreasing even though the position was short. This was because the collateral itself was measured in BTC. Apparently MEXC calls this a Coin-M pairing.

The vast majority of perpetual futures pairs on this exchange are collateralized in USDT, which makes sense. You'd want the collateral to normally be an unchanging number to be measured against. In fact, MEXC only has two of these Coin-M pairs: BTC/USD and ETH/USD.

The interesting thing here is that I'm fairly certain that USD doesn't even exist on MEXC. USD has no spot pairs and withdrawing it is not an option. Rather, it is just used here as a unit-of-account on the ledger to measure who is winning and losing the long/short game.

The point?

So what I ended up realizing in that moment is that trading on leverage can be balanced in such a way that we can mimic a stablecoin using these Coin-M pairs to create an equalized position. Going x1 short on BTC/USD creates a virtual stable that does not go up or down in value.

Why is that?

Because when Bitcoin goes up a short loses value, and when Bitcoin goes down the short is up value and the collateral is down. These two positions together create a weird kind of derivative stable-coin... but why would we ever want to do this? The answer is the funding rate.

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These are the two funding rates for BTC/USD and ETH/USD perpetuals on MEXC. The funding rate exists to give a financial incentive to liquidity providers to balance the orderbook. For example, if everyone is going long and nobody is going short on Bitcoin... well then the price of Bitcoin on the futures market is going to be higher than the spot market... which is certainly not ideal. Without some kind of financial incentive to balance it out there would be horrible depegs that caused this type of financial asset to be largely worthless.

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So what the funding rate does is that it forces one imbalanced side to pay the other in order to get the peg back to where it's supposed to be. But is it really worth it? The math says yes. In fact the math says yes with a cherry on top.

The reason for this is that crypto traders are complete degenerates and we are in the middle of a bull market. The futures market is usually going to be net-long because going long on crypto can result in theoretically infinite gains (+100% +500% +1000%) while a short can only at maximum get a 100% gain on what was borrowed (and that assumes the asset has crashed to zero which is almost never the correct expectation).

At best someone shorting the market might expect to make +50% on what they borrowed if they get very lucky and the underlying asset drops 50%. More often than not they might shoot for a 10% to 30% gain, or less.

For all these reasons and more, perpetual futures will almost always use the funding rate to syphon capital from the longs and give it to the shorts during a bull market to sweeten the deal on the other side of the trade. As we can see above a very good funding rate is going to be something like 0.1%. Keep in mind that this is charged to the longs and given to the shorts every 8 hours. 0.1% doesn't sound like a lot, but it adds up quick.

For example, a funding rate of 0.1% happening 3 times a day is 0.3% a day. Multiply that by 365 and we'd get an APR of 109.5%. But what would the APY be? If we rolled all of that yield back into the position it would be 1.001^(365*3) = +199%... so near double the yield as compared to non-compound interest rates.

Of course it's not really possible to get that high of a rate over a long period of time, but it doesn't matter because even the average is pretty good. My napkin math estimate on what the rate might be in the current climate was something like 40% APY. And we thought HBD yields were good.

This leads me to wonder why nobody seems to talk about this strategy for yield farming. Of course it's not hard to guess why that might be. Crypto enthusiasts hate leaving their money on exchanges due to counterparty risk. On top of that crypto enthusiasts are also degenerates looking for a 10x gain not paltry 40% yield on a stable coin. That's exactly why the rates are so good in the first place.

So how do we set one of these positions up?

It's pretty simple. Just set leverage to "isolated" and "1x". Make sure it's a Coin-M perpetual (BTC/USD ETH/USD) and borrow as much money as you want (up to x1 the amount of the total BTC or ETH collateral in your account.

To ensure that we've set up the position correctly we can then set our stop-loss to trigger at -99% ROE. This stop-loss should be nearly impossible trigger. Why? Because losing 99% on the position means that Bitcoin has gone x100 to $6,759,600 as we can see in the screenshot I took yesterday.

Even if BTC were to spike x100 and this stop-loss did trigger, we haven't lost any money because while we lost 99% of our Bitcoin collateral... the 1% that's left over is worth x100 times more than it was before the pump, which is a breakeven position in terms of USD. Again, it's a self-balancing position that earns yield no matter what happens.

Why does anyone hold stablecoins on exchanges?

There are millions of people running around holding their USDT/USDC on exchanges and getting zero yield on those positions. If they sold those stables for Bitcoin or Ethereum they'd be able to set up one of these hedges to farm these free yields on any platform with these types of perpetuals.

Of course the yield is not guaranteed

If the positions flipped and the funding rate went negative then the shorts would be paying the longs and we'd lose money on this position. However we could just sell the Bitcoin into USDT and go long with USDT collateral in that other pool to take the other side of the trade once again (in the bear market). Going x1 long with USDT collateral is exactly the same as going short x1 with BTC collateral. It's stable. The only difference is the funding rate and which side is paying who.

However we all know that the degenerates in crypto are going to keep going net long for quite a while. The bears will be the ones being paid until it's an actual bear market and sentiment has shifted. We have to assume that this funding rate will only get better and better as the bull market ramps up and users get more and more greedy with their gambling habits.

Conclusion

It's obviously not a great idea to purposefully hold crypto on exchanges, but if you're doing it anyway and holding stables on an exchange this tactic can be employed to basically get almost risk-free high yields on an asset that was just sitting there doing nothing. If the exchanges are going to pay us to help them balance the perpetuals markets then why aren't we doing it? Degens gonna degen.