In our previous article (link here) we discussed trading strategies to profit from speculating in interest rates. This article will present more advanced trading strategies such as: spread arbitrage, hedging and yield curve term structure.
Advanced Trading Strategies
Arbitrage Different Funding Rates
If you want to buy BTC perpetual futures on FTX or Binance, you must pay a funding rate. However, a savvy trader will notice these funding rates are not always the same, which presents an opportunity. By arbitraging interest rates on Strips, you are betting that the interest rates for the same underlying asset should be equal.
Even the most liquid BTC perpetual futures have very different funding rates.
Example: Binance vs FTX funding rate
- The 8hr funding rate for BTC perpetuals on Binance is 0.01%. The funding rate on FTX is currently -0.0016%.
- With $100,000 collateral and 10x leverage, you can long the Binance funding rate and short the FTX funding rate. You can collect $348 (0.348%) return a day, or 127% annualised return!
Example: dydx DAI vs Compound DAI
- DAI on Compound lending rate is currently 4.45%. DAI on dydx lending rate is currently 0.73%.
- With $100,000 collateral and 10x leverage, you can long the Compound lending rate and short the dydx lending rate. You can collect $101.92 (0.101%) return a day, or 37.2% annualised return!
Example: Perpetual Funding rate between 2 exchanges
- Orange: Annualized funding rates of OMG Perp on FTX
- Turquoise: Annualized funding rates of OMG Perp on Binance
- Dark blue: difference between 2 funding rates
At the beginning FTX’ rate was much higher than the same rate on Binance, which created a difference of 10.7%. At the moment, there is no easy way to short the interest rates. With STRIPS providing the platform, traders could have:
- Long Binance > OMG-PERP Funding (pay fixed and receive floating at -1.98% at the beginning)
- Short FTX > OMG-PERP Funding (receive fixed and pay floating at 8.4% at the beginning)
- Lock in the yield difference at 10.7%
Not surprising to see the rate difference collapsed to 0%. By closing the arbitrage positions above, the trader will receive
- Short Binance > OMG-PERP Funding (receive fixed and pay floating -0.0295%)
- Long FTX > OMG-PERP Funding (pay fixed and receive floating at -0.03%)
- Unwind and realize the profit from yield difference collapsed from 10.7% to -0.15%
In conclusion, STRIPS’ IRS markets can be used to trade any kind of interest rates (funding / lending) on any platform (CeFi / DeFi) for any period of time (perpetual or fixed). STRIPS enables trading interest rate as an important asset and establish an efficient and fair marketplace for interest rates.
Hedge Yields
- Hedge Yield Farm Returns: yield farmers can hedge yield farming returns by shorting the
- apparently short perpetual IRS can lock in the fixed return as certain income while traders expect APY% to decay. Furthermore, short IRS’s profits can further increase if market fixed rate trends lower as well.
- Hedge perpetual futures’ funding rate: short perpetual or fixed term IRS (such as 3 months) can also lock in the fixed rate as certain funding costs if the funding rate spike on exchanges. Below is a quote received from one of our ambassadors describing IRS as a tool to hedge his perpetuals funding rate on exchanges.
“As a trader myself (for both FX & Crypto), funding rate is something I am concerned a lot. I moved my Futures contracts trading activities from Binance to Bybit few months ago because Binance banned Hong Kong Based users on derivatives products. However, given the differences of liquidity and user base, the funding rate was so much different (I am saying funding rate of Bybit is few times higher than Binance!), which means my cost of trading goes up significantly.
Imagine if I can swap my floating interest rate to a fixed one, I would be able to manage my PnL and position much easier.”
- Hedge for Basis Trades: traders can also use IRS to hedge against their basis trade on futures. For example, if 3 month futures basis is 24%, the 3month fixed rate on STRIPS if 20%. Without STRIPS: normally to capture futures basis, you sell futures and buy perp, however you will pay funding fees on the perp. If you hold this position for 3 months — you are paying 3 months of perp funding. There is a risk that the perp funding you pay is more than the futures basis. If there is a market for the perp funding rate, then the trader can hedge his funding rate by going long the 3 month IRS (pay fixed, receive float). If the fixed rate is 20%, and the futures basis is 24%, then there is a 4% risk-free profit.
Shape of yield curve and more…
STRIPS plans to launch fixed term IRS in the future: this opens up unlimited trading opportunities in the shape of the yield curve.
- Traders can put on steepening and flattening between fixed term vs. perpetual
- Traders can bet on convergence and divergence of rate difference (between floating and fixed) across the terms. If 1yr fixed rate is in deep discount while perpetual fixed rate is not, then traders can long 1yr and short perpetual if the trader thinks such divergence will converge eventually
Extended Applications
So what’s the future and potential of Interest Rate Swaps?
There are tons of things that can be built on top of an efficient IRS market…
- Fixed rate perpetual bonds: these are fixed yield bonds that will pay forever. Imagine a bond that will not only pay you to retirement, but pay your kids, and your grandkids. This is generational wealth.
- In the future, any lending/borrowing protocol can use our APIs to create their own fixed lending and borrowing markets and bonds. Open-sourced fixed-rate lending and borrowing for all platforms. Platforms and companies can whitelabel their bonds, and Strips acts as the clearing/settlement platform and source of liquidity. STRP holders will benefit from this.
- USD lending and borrowing institutions to hedge their interest rates. Company treasuries need certainty in their lending and borrowing costs. There currently doesn’t exist anyway for lending and borrowing companies like Blockfi, Celsius, Circle, Matrixport etc. to hedge their interest rates. They are exposed.
- Miners borrowing USD, who want to hedge their borrowing costs (miners borrow hundreds of millions a year in short term loans and they are most affected when funding rate spikes). When interest rates spike, that is millions of dollars of additional cost that these miners have to pay. We lower their cost of hedging so they can focus on the more important things.
Disclaimer
Any past performance, projection, forecast or simulation of results is not necessarily indicative of the future or likely performance of any investment. The information and publications are not intended to be and do not constitute financial advice, investment advice, trading advice or any other advice or recommendation of any sort offered or endorsed by Strips Finance.
Strips is currently hiring for several roles. Interested applicants can email their resume and cover letters to jobs@strips.finance.
To learn more please visit the project’s website at https://strips.finance/ or follow the project on
