[Strategy Paper] Hedged Futures in CEX
Disclaimer: this is a dominant strategy and the base strategy of the Serenity Fund.
This strategy is probably the simplest of all, too simple so that it might not be called as a strategy. As an integral part of our operations, we will explain the returns and risks of this strategy in this article.
CEX (centralised exchanges, in this case, we use Binance as a reference) are not a favourable term in defi fans’ eyes. CEX means centralisation and is against the doctrine of decentralised finance. We are neutral in our stance as to how the crypto financial system will evolve, as neutral as we operate this risk-neutralised fund. Having said that, there’s an inherent risks of any institutions organised centrally — as decentralisation does have merits — CEX like Binance might be dysfunctional because of government intervention, management ill-intention or internal fraud, etc. which have a less chance to happen in a decentralised system.
If you are fine with the risks above, then strategy execution is simple: buying a token and short the full amount of this token in Binance’s Coin-Futures. Coin-Futures are futures where you use tokens as collaterals.
For instance, if you purchased 100 ETH and short 100 ETH in ETHUSD perpetual, then you are ETH-price neutral. There’s a detailed guide on Binance about Coin-Futures. https://www.binance.com/en/support/faq/a3401595e1734084959c61491bc0dbe3 It’s justifiable to invest some time to understand how it works.
Put it in a simple sense, your Profit(loss) = position_size * (1 / entry price — 1 / exit price). And your Total value = Value of Collaterals + Profit (loss).
So if you start with 100 ETH at market price of $500, use this as collateral and short 100 ETH in Coin-Future, then at any point of time your total value is $50,000. For instance, if the price rises to $1000, then your loss of the Coin-Future will be 50000 x (1/500–1/1000) = 50 ETH, and your total value is (100 ETH x $1000–50 ETH x $1000), still $50000.
You will also never have a margin call, as your collateral increases as the same speed as the market price.
Your earnings will be funding rates on your positions: https://www.binance.com/en/support/faq/360033525031 Please see the detailed guide here.
Funding Amount=Nominal Value of Positions* ×Funding Rate
*Nominal Value of Positions = Mark Price x Size of a Contract
Funding rate is settled and paid every 8 hours. For instance, for the last week, Binance’s funding rate gave a annualised return of 19.1%.
It’s interesting to note that most CEX, starting from Bitmex, built in design a base rate of 0.01% per 8 hours.
Funding Rate (F) = Premium Index (P) + clamp(0.01% — Premium Index (P), 0.05%, -0.05%)
There’s not scientific reason why this is 0.01% or annualised to be 10.95%. It probably reflects the level of risk free rate in the crypto industry now. Funding rates can be negative when the market has a negative sentiment.
Some tokens, especially the mainstream ones like BTC or ETH, gives a stable funding rate; whilst other newer tokens or tokens with smaller market cap will have a fluctuating funding rates.
This strategy could work alone or coupled with investments in Uniswap, as explained in our earlier Strategy Paper — Hedged Liquidity Providing. The difference is that you can also use USDT-Futures for capital efficiency. The funding rates between USDT-Futures and Coin-Futures are different, but closely track each other over a period of time.
(Serenity Team, 2 Dec 2020)