Hey all!
Today I will share an alpha strategy, for people that would like to make some great money on their fiat. This strategy is a relatively low risk high reward investment.
TLDR:
- Buy bitcoin with fiat and immediately short it 1x on Bitmex to receive funding rate.
- Risks: possible negative interest, exchange rate risk (USD goes down respective to your local currency) and exchange risk (Bitmex defaults).
- Returns are high in a bull market (50%+ a year), bear market negative return.
I’ll first explain some mechanics about the Bitmex contract (needed to understand the strategy), then how the strategy works and lastly the risks.
As most of you know the Bitmex perpetual contract is kind of an unlimited futures contract which settles in BTC. In other words, there isn’t any USD involved, everything is done in BTC. Since we are going to short XBTUSD, let me give an example.
Let’s assume BTC trades at 10000, you short 1 BTC at 10000 at 1X leverage (so no leverage). This means, that you are synthetically LONG 10k USD, i.e. we don’t own real USD. However, by the construction of the derivative as long as the position is open, we have 10k USD in BTC forever. So, assume BTC moons to 20k and you close your position, you now own 0.5 BTC, because 0.5*20k = 10k. So, we own 10k USD in BTC, which we can then sell immediately to get 10k USD in real $$$. Now assume, that instead BTC goes to 5k, then if we close our position, we own 2 BTC, because 2 * 5k = 10k. Which we can then immediately sell again for 10k USD. Note, that we can not get liquidated by our 1x short (only if funding rate is negative for a long time and you don’t do anything about that).
Now that we got this out of the way, how is this 1x shorting going to make us money? It has to do with how the perpetual contract works. Since it never settles, Bitmex must make sure that the contract value is close to the real trading value of BTC. This is done by the funding rate. I’ll give an example, because it is the easiest way to understand it in my opinion. Assume the contract trades at 11k, while you can buy real bitcoin at 10k on exchanges. Bitcoin is trading 1k higher in the contract than at exchanges, which should NOT happen! We need a way to incentivize people to close their long position and/or go short, so that the price goes down to 10k (the real bitcoin price). This is where the funding rate is needed. You can see funding rate as another word for interest rate. If the funding rate is positive people who are long pay shorts an interest rate and if negative shorts pay longs. This interest is what incentivizes people to close their long position, because they will now lose money no matter what the price of bitcoin does. And other people to short, because they can get interest on their position AND do a risk-free arbitrage (buy on exchange and short at Bitmex, because BTC is cheaper on an exchange than on Bitmex). Remember, this system also works the other way around. If the contract price is lower than the real bitcoin price, shorts pay longs (bulls) interest. This funding rate is paid every eight hours and changes dynamically. More information about funding rate is available on Bitmex.com.
In practice, these deviations are way lower, but you get the idea. These small deviations must be corrected. Furthermore, in bull markets the funding rate is often positive (see https://www.bitmex.com/app/fundingHistory?start=0). I have to add here, that if there was no deviation, longs would pay shorts 0.01% every 8 hours (because the interest on USD is higher than BTC). This is obviously positive for us.
So, we now know how the funding rate works and how shorting works. The plan is as follows, when we are in a bull market, we buy BTC with fiat and immediately transfer it to Bitmex to then short it at 1x. Let’s assume we buy 1 BTC at 10k and then immediately short it at 1x at 10k. We now have a synthetic long USD 10k position and because we are in a bull market, we will often (9/10 times) get positive interest rate. When the interest seems to be negative for multiple times, we close our position and immediately sell our BTC on the market to get back our USD + interest. But it gets better! Remember when interest rates are negative? It is when the price of bitcoin is trading lower at Bitmex than on the market. So, we get back our USD + interest + arbitrage.
If this sounds too good to be true, then you are right. There are definitely some risks involved.
Firstly, we got exchange rate risk, I am a European, so I got EURO’s. When I am short 1x at Bitmex I am synthetic long USD. It could happen, that in the meantime USD goes down relatively to Euro’s. So that I get back less Euro’s when I close my position by selling the BTC to EUR. This risk is not that big, because currencies don’t move that much from each other (You can hedge yourself against this risk, I might explain that in another post if there is interest 😉).
Secondly, we got the negative interest rate risk. There might be sustained time, where interest rates are negative. You can mitigate this by just checking once every couple days to make sure interest rates are not deeply negative. Remember when interest rates are negative, you get a free arbitrage by closing your position! So it is better to then just close it. If people are interested, I could make a bot that checks the expected funding rate on Bitmex and send notifications via email if it is negative.
Thirdly, is the exchange risk. Bitmex could default or get hacked etc. I see this is as the smallest possible risk. They use multi-signature cold wallets and have a MASSIVE insurance fund (almost over 30k BTC is in it).
I hope I have explained the strategy well and please let me know if you got any more question. I’d love to help!
If you want to support me, please use my referral link on Bitmex. It will give you a 10% discount on trading fees for 6 months and I’ll get a bit of Bitmex’ fees. https://www.bitmex.com/register/tcWRoM
Or buy me a beer 😉:
BTC: 1FuT78T2imUfq3F7Mce3ZWSSTS3nLAr7GR
ETH: 0xae62663EAe128682B7A81CdBe99b0F8A6f57c84D
One more thing I want you to warn you about. ETHUSD also has funding and these interest rates are way higher. This does not work the same as the XBTUSD contract. ETHUSD is a quanto, which has different risks. NOTHING in this article applies to that contract! Don’t fall for it.
Take care!
Source: https://blog.bitmex.com/earning-interest-income-on-xbtusd-with-minimised-risk/
