The ultimate guide on how to Contango
Learn the ropes of trading using Contango and how to benefit from its cheap funding and arb opportunities.
The information provided below is for research purposes only. It should not be used as investment advice. Trading on leverage carries significant risk. If you are a beginner DO NOT trade on leverage.
Note: we use “Contango” to indicate the protocol, and “contango” to refer to a bullish market condition where longing an assets implies paying a premium.
Contango v2 offers perp built in a novel way, on top of spot and lending markets.
Contango builds perps by automating a looping strategy, through flash loans. When a trader opens a long ETH/DAI position with DAI as margin, the protocol gets the remaining DAI from a flash loan, swaps all DAI for ETH on the spot market AND lends back ETH on the money market to repay the flash loan.
At a high level, Contango positions behave like any other perp you can find in CeFi or DeFi. But they also unlock new use cases that are specific to their design. For more context on how Contang works, read Contango: the looping layer of defi.
The goal of this article is to provide a comprehensive overview of possible use cases. We have grouped them in 6 areas:
- Speculation
- Hedging
- Arbitrage (funding rates, USD rates)
- Farming yield (correlated assets)
- Farming rewards
- Farming points
We accompany each scenario with detailed examples which you can also find on this spreadsheet (it’s read-only so make a copy for yourself in case you want to play with numbers).
1. Speculation
Contango positions on non-correlated pairs (like ETH(USDC) can be interpreted as perps.
Reminder: perps are different from dated instruments as they have no maturity and have a variable funding rate that you either have to pay or receive depending on market conditions.
- If you are bullish on ETH, you can go long: if in a few weeks ETH price is higher than the price you paid when you entered the position, then you have a profit (given that if you had to pay funding, this didn’t offset your gains completely).
- If you are bearish on ETH, you can go short: if in a few weeks ETH price is lower than the price you paid when you entered the position, then you have a profit (given that if you had to pay funding, this didn’t offset your gains completely).
You can apply the same reasoning for stable vs stable pairs, like DAI/USDC: if DAI trades below $1 and you expect it to regain the 1:1 peg with USDC, you can long DAI with up to 13x leverage and eventually make a profit when it trades back to $1.
Remember: you can amplify your gain (and losses) with leverage. Trading on leverage carries some risk as you can get liquidated and lose your initial investment.
Example
For this example we use stETH instead of ETH as funding rates are inherently better thanks to the native yield of stETH. So longing stETH/USDC is normally cheaper than ETH/USDC; the liquidation threshold, however, is worse.
Let’s say the current spot price of stETH is 1000 USDC.
The sentiment is optimistic so the market is currently in contango: longing an stETH/USDC pair at 3x leverage has a negative funding rate (APY), which is partly offset by the native yield of stETH; let’s assume the net APY is -5% and doesn’t change through time.
A trader believes the price of stETH/USDC will go up over the next 3 months. So she goes long stETH/USDC for a size of 1 stETH. She posts 250 USDC as collateral (so leverage is 4x).
After 3 months she closes her position. As expected, stETH appreciated to 1100 USDC so she has a gross PnL of 100 USDC. However, she has to pay funding for the 3 months she kept her position open: 1000 USDC * 5% / 4 = 12.5 USDC. So her net PnL is 87.5 USDC.
Her ROI is 87.5 USDC / 250 USDC = 35%.
Set up your own example here.
2. Hedging
Perps can be used to hedge investments by taking the other side of the market: e.g. go long on an asset, go short on the perp instrument on that asset.
When hedging with perps you have to face the unpredictability of funding rates (as a reminder, on Contango they’re only charged when closing a position).
Luckily, Contango has the least volatile funding of the crypto space. See this article for details.
Example
A trader has a 1 ETH stack and, facing an unpredictable event (e.g. the Merge), she decides to hedge the same amount on Contango to be delta-neutral and avoid being exposed to price fluctuations for 1 week. Let’s assume the ongoing funding rate for ETH/USDC is -5% and doesn’t change through time.
She shorts the same size of her stack, 1 ETH, through an ETH/USDC pair. Given the design of Contango she can choose to post either USDC or ETH as margin, so to avoid swapping she opts for posting 0.4 ETH as collateral (so leverage is 2.5x).
The current spot price is 1000 USDC, and after the Merge it goes down to 900 USDC.
She closes her position after 1 week: her spot leg loses 100 USDC, while her short on Contango has a gross PnL of 100 USDC. However, she has to pay some tiny funding, (1000 USDC * 0.05 / 52 = 0.96 USDC), so her net PnL on the short is 99.04 USDC.
She effectively hedged her position, paying little funding in the meanwhile.
Set up your own example here.
3. Arbitrage
Arbitrage revolves around the idea of earning any spread you find across different pairs, markets or chains, either thanks to rates differential and/or rewards.
Given that Contango offers arb opportunities across multiple markets and chains, it helps making defi markets more efficient, in terms of both spot price and interest rates.
Implied funding rate arbitrage
If the market is in contango and the implied funding rate on a short is positive (meaning: you are getting paid to keep your short open), the idea is to create a delta-neutral position with a 50% spot leg and 50% short perp leg that earns a positive cash flow from funding rates. A detailed description of this trade can be found on Artur Hayes’s blog.
There a few key aspect to take into account when thinking about this arb on Contango:
- First, it’s worth noting that, on Contango, the implied funding rate is given by the net APY of lending and borrowing rates on the underlying lending market.
- Second, please be aware that bigger and more battle-tested markets like Aave and Compound offer pretty stable funding across time. Smaller and less known markets might have more volatile rates that could spike more often and offer more enticing returns — although for shorter periods of time.
- Lastly, because of how shorts work on Contango, doing this arb with a spot leg is equivalent to just lending the quote currency. So, to make it worthwhile, the other leg of the trade should have some leverage in it, either by taking the opposite side on another perp venue or -even better- on another market on Contango (so you can easily monitor both legs on the same interface).
Example
A trader realizes that the wstETH/USDC.e market is in contango on Polygon/Aave v3 with an implied funding rate (APY) of +16.82% when shorting, and in backwardation on Gnosis/Aave v3 with an implied funding rate (APY) of +1.13% when longing.
Noticing this discrepancy, she opens these two legs of her trade by going long and short for a quantity of 1 stETH, at 3x leverage, with approximately the same margin, around 1000 USDC.
Set up your own example here.
If these APYs remain constant over a year, she will keep receiving funding rates on both legs. As a reminder funding rate payments are accrued on a per block basis but are settled when the position is closed.
After 1 year she closes her position, and regardless of the ongoing wstETH price, she has collected +1.13% and 16.82% of her position size in funding fees. Being delta neutral, whatever her PnL on the long leg will offset the PnL on the short leg of the trade.
Her ROE depends on the leverage she took, 3x, so it’s around 3.39% on the long and 67.28% on the short. Her final ROE takes into account the initial margin she had on both legs, so it’s the average between the two, 35.34%.
Important: in reality, funding rates fluctuate over time; if rates look juicy this is often due to a spike on the underlying lending markets so this type of trades are normally performed for shorter periods of time, to take advantage of discrepancy in interest rates. Also, due to leverage, positions could get liquidated and traders might need to rebalance accordingly.
Stable pairs
A similar trade aimed at collecting funding rates can be performed with just one leg, using stable pairs, e.g. DAI/USDC (with some price risk), or USDC.e/USDC (with almost no price risk).
Example
A trader notices that USDC.e/USDC on Polygon/Aaave v3 offers an implied funding rate of +7.13% (85.51% in ROE terms). Given that USDC.e and USDC are the same asset, their prices move in tandem, so she’s confident opening at 12x leverage, with a 3.51% liquidation buffer.
Using high leverage allows her to be capital efficient and collect these positive funding for a full size of 10,000 USDC, with just 883 USDC as margin.
Aware that funding rates might drop back to their normal levels, she keeps her position open for a week, during which the rates remain stable around 7%.
After closing her position, since the price for USDC.e/USDC has always been the same, she nets a profit from the funding rates she has collected so far, around 0.13% (around 1.63% in ROE terms).
4. Farming yield (correlated assets)
Although some users employed looping to obtain a leverage exposure (in other words, a speculative position as described at point 1), many others used it to simply “farm” the net APY from lending markets, i.e. benefit from the difference between lending and borrowing rates, which could be considered a funding rate arbitrage as explained above.
Since the advent of liquid staking tokens, like stETH, and their listing on lending markets like Aave, users have flocked en masse to loop them: they are same-flavor pairs which are less volatile, have higher leverage, and a more predictable — and positive! — funding APY.
stETH is a rebaseable ERC-20 token that represents Ether staked with Lido and increases in balance every 24 hours through a supply rebase to represent the rewards earned via staking. A non-rebase wrapped version, wstETH, has been created to allow for a seamless integration of staked ether across DeFi protocols. Instead of rebasing, wstETH balance is kept constant and the token simply increases in value over time (denominated in stETH). See more details on Lido’s docs.
If you have some Ether staked and want to increase your exposure, you can loop it in 1 click on Contango by going long on stETH/ETH. Given the wide selection of lending markets that Contango integrated with, traders can choose the market and chain they prefer. Similar loops can be done with rETH, stMATIC, MaticX.
Example
A trader has 1 wstETH and decides to leverage it to gain extra yield. She posts the full 1 wstETH as margin (on Contango you can switch between size and margin as inputs) and chooses 12x leverage, on a lending market that offers an estimated ROE of 15%.
If she keeps her position open for a full year, monitors it frequently to modify leverage if needed, then her ROE will be around 15%, assuming rates haven’t changed significantly.
5. Farming rewards
By design, whatever reward is offered to borrowers and lenders on the underlying money markets can be accrued by Contango traders that use those markets.
The same logic from the examples in the previous sections can be applied to trades aimed at farming rewards.
Example
A trader notices that longing DAI/USDC on Arbitrum/Lodestar at 3x offers an implied funding rate of +3.63% (10.9% in ROE terms) plus 16.67% of LODE rewards.
Given that DAI and USDC are highly correlated as they’re both pegged to USD, she’s confident opening at 3x leverage, with a 11% liquidation buffer.
The implied funding rate might change and even go negative over time, but as long as the annualized rates she gets from the emission of rewards are higher than the annualized negative funding, then she’s always earning a profit in LODE rewards.
Farming points and airdrops
Lately, many protocols have started offering points to reward users for engaging with their product; and points have often turned out to be a claim on real tokens later on.
By trading on Contango, traders engage with underlying assets on money markets that often offer points too. Contango marks with a 🪂 icon all pairs eligible for points (and confirmed airdrops). Examples include: EigenLayer points, Ether.fi points, Ethena sats, Renzo points, Aave merit rewards, Spark airdrop.
About Contango
Contango lets you loop anything on-chain. You can create leverage (re)staking positions, arb rates differentials, farm points, or simply go long or short like a perp at low funding. Ape in like a degen with 1-click Strategies, or trade like a pro on the sleek Trade interface.
