Author: Climber, LianGuai
Since the significant decline in the cryptocurrency market in mid-August, the market has experienced little volatility in the past month and a half, with the price of BTC remaining around $26,000. However, there are still several tokens on Binance that have seen significant increases, such as TRB, HIFI, UNFI, PERP, LPT, and others.
However, it is worth noting that Binance usually releases announcements about a week after these tokens have experienced significant increases. These announcements usually involve adjustments to the leverage, margin tiers, and funding rate ceilings of perpetual U-based contracts for these tokens. After these adjustments, the prices of these tokens tend to experience significant declines.
Extreme price fluctuations are common in the cryptocurrency market, but in these recent battles between long and short positions, the short positions have suffered heavy losses. This is largely due to the long positions taking advantage of the funding rate mechanism for arbitrage. However, this profit-making strategy has been exposed by the top CEX Binance after multiple instances and has continued for over a month. Recently, IMX has announced funding rate adjustments shortly after experiencing a significant increase in price for just half a day.
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So what exactly is the funding rate? How do market makers take advantage of it for arbitrage? Can similar arbitrage strategies continue in the future?
Notable example of funding rate arbitrage: TRB
The funding rate is a fee set by cryptocurrency exchanges to maintain the balance between the price of a contract and the price of the underlying asset. It is typically applicable to perpetual contracts.
It is a mechanism for fund exchange between long and short traders, and exchanges usually do not charge this fee. It is mainly used to adjust the cost or profit of traders holding contracts in order to keep the contract price close to the price of the underlying asset.
When the price of a perpetual contract deviates from the price of the underlying asset, the exchange adjusts the funding rate to incentivize the long or short positions to pay funds in the opposite direction, thus bringing the contract price back in line with the price of the underlying asset.
In general, when the market trend is bullish, the funding rate is usually positive and increases over time. At this time, the long positions pay the funding rate to the short positions. Conversely, when the market is bearish, the funding rate is usually negative, and the short positions pay the fee to the long positions.
Currently, the cryptocurrency market is in a deep bearish phase, with the bearish forces dominating. Some investors specifically target this group and induce short positions by significantly increasing the prices of tokens with low liquidity and market capitalization, and then take advantage of the already negative funding rates for arbitrage.
Among these tokens, TRB is particularly notable.
Since reaching a historical low of $6.67 in June 2022, TRB experienced a significant increase after just two months, and has been relatively quiet since then. Even during the market rally at the beginning of this year when BTC prices doubled, its trend remained stable.
However, starting from the end of August this year, TRB suddenly began to rise, doubling in price and continuing to increase significantly. Eventually, it reached a temporary historical high of $48.90 after multiple increases, with a staggering increase of about 500% in just half a month.
Due to the current deep bear market phase, tokens that have risen several times are often targeted by bears. Therefore, a large number of short positions are set up on TRB perpetual contracts. However, the price of TRB has remained high before Binance announced the adjustment notice, and what is frightening is that the funding rate of TRB perpetual contracts has reached -3% at this time.
According to the funding rate mechanism set by the trading platform, short traders at this time need to pay fees to longs. Binance’s settlement period is once every 8 hours, which means that short positions that ambush TRB have to transfer 3 fees to longs every day.
If a short position is set with 10x leverage, it needs to pay a funding rate fee of 30% to longs each time. This is difficult for any investor to bear.
As can be seen from the above figure, the funding rates of TRB on multiple well-known exchanges are negative, especially Binance and OKX have higher frequency and peaks.
What is even more surprising is that this situation has lasted from September 12th to September 16th. TRB shorts not only have to bear the short pressure brought by the rise in token price, but also face huge funding rate pressure every day.
Faced with such manipulation in the cryptocurrency market, some netizens exclaimed that this time the market makers not only want to harvest the retail investors but also uproot them.
Although late, it stopped temporarily at IMX
In fact, the use of perpetual contracts for arbitrage has been around for a long time, but it is not commonly used. This is mainly due to certain risks, such as the reversal of funding rate values, extreme market fluctuations, long bear markets, or declines in token prices, etc.
It is the obligation of exchanges to maintain market balance and protect investors. Binance has frequently taken action against market makers who repeatedly use funding rate arbitrage in bear markets.
As can be seen from the above figure, starting from August this year, Binance has significantly increased the frequency of issuing such announcements, but most of them were only issued after the above-mentioned tokens such as HIFI, UNFI, PERP, and LPT rose significantly last week, and the main changes were adjustments to the leverage, margin tiers, and funding rate cap of the corresponding token’s perpetual contracts.
Using TRB as an example, Binance has adjusted the settlement frequency of TRB U perpetual contract funding rate from once every 8 hours to once every 4 hours, and the funding rate cap multiplier has been raised from 0.75 to 1.
In addition, the Binance team stated that in order to protect user rights and reduce risks in extreme market conditions, Binance contracts may take additional protective measures for TRBUSDT U perpetual contracts without further notice.
Potential protective measures include but are not limited to adjusting leverage and margin (including the maximum leverage ratio, position limits, and maintenance margin ratio for each tier), adjusting funding rates (including the base interest rate, premium index, and fee cap), changing price index components, or adopting a “latest transaction price protection mechanism” to update the mark price.
This also means that Binance will have corresponding measures to curb such misconduct in response to the actions of market makers.
Interestingly, every time Binance announces an adjustment to the funding rate, these coins that have experienced significant increases without exception experience significant decreases. Additionally, the funding rate gradually shifts from negative to positive to varying degrees, as shown in the above chart.
Perhaps due to the frequent manipulation of the funding rate by these market makers with ulterior motives, the Binance team has become vigilant. Therefore, on September 20, in the face of the sudden sharp rise of IMX, an announcement was issued to adjust the funding rate in just half a day.
The effect is also evident: IMX no longer continues to rise, and the decline is about 15%. Especially after the funding rate reached -2.5% on September 21 at 16:00, it rebounded to around -0.72% on the same day. If IMX continues to rise, the bears of IMX may likely encounter a fate similar to the investors shorting TRB.
However, countermeasures always have a lag, and investor levels vary. It is difficult to say that such arbitrage methods will not continue to be effective in the future.
Conclusion
There are various derivatives in the financial market, and the method of using low-market-cap tokens like TRB and taking investor funds through the contract funding rate mechanism is not necessarily clever. It is only extremely useful during the bear market phase with low liquidity and a lack of profit-making effects.
Because fundamentally, the bears who suffer huge losses enter the game and place bets based on their expectation that the target token is likely to enter a downtrend. However, this time, the hunter becomes the hunted.
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