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Basis Trading

Basis trading is a financial trading strategy which consists of the purchase of a particular financial instrument or commodity and the sale of its related derivative.

This article introduces a basis trading strategy that allows the trader to earn funding payment without position exposure.

Funding Payment

MCDEX perpetual is a derivative pegged to the underlying index by funding payment. Such funding payment is executed every second according to the funding rate which helps to keep the price of perpetual swap close to the price of the underlying asset.

Some perpetual markets, like ETH-BUSD, BTC-BUSD, have positive funding rates for most of the time. The market has positive rates on these trading pairs most of the time (as shown in chart below). **A positive funding rate means the longs pay funding to the shorts.** It happens when they are more longs than shorts in the market.

BTC-BUSD funding historical chart from Oct. 16th to Oct. 22th

There is the “Base Funding Rate” parameter, which aims to account for the difference in interest rates of the base and quote currencies.

The Base Funding Rate is set at **0.01%/8-Hour (10.95% Annualized)**.

This Base Funding Rate is added to the funding rate. As a result, whenever the AMM holds a short or zero position, the funding rate is always larger than the Base Funding Rate.

Strategy

As the funding rate is always positive, the trader can earn this funding by shorting the perpetual. To hedge the short exposure, the trader can long spot concurrently.

**The Basis Trading Strategy: **

- 1.Buy some amount of spot coin in the other markets
- 2.Sell (short) the same amount of perpetual on the MCDEX

The same amount of spot and perpetual position nets off and creates a risk-neutral portfolio. In addition, the short position earns funding, which is the alpha of the strategy.

To increase capital efficiency, the principal used as the collateral of the short position may be less than the overall spot position. It means that the trader deploys leverage when shorting the perpetual.

Re-margin

The trader needs to re-margin in the event when the spot price goes up so that the short position will not be liquidated.

- 1.Sell some spot + unwind the same amount of short perpetual on MCDEX
- 2.Add more stable coin margin to the short position

Profit Analysis

The revenue of this strategy comes from the funding payment, while the cost comes from the trading fee on the spot and perpetual markets.

Suppose the trader has P USD principal and buys the spot coin with α percent of the principal. The remaining principal is used as the collateral when short the perpetual contract. The amount of the spot and short should always be equal. So the initial value of the spot coins and short perpetual position is P * α.

The initial leverage of the short perpetual position is α / ( 1 - α). When α is larger than 50%, the leverage is larger than 1x. Suppose the max leverage of MCDEX is 10, the max value of α is 10/11 (90.9%)。

Considering the open and close the portfolio need to pay the trading fee twice and ignoring the re-margin cost, the APY of the strategy is:

where: α is the percent of the principal swapped for the spot coins γ is the average annualized funding rate during the strategy φ is the sum of spot trading fee and perpetual trading fee

Suppose, α = 0.75 (leverage of the short position is 3x), γ = 20%, spot trading fee is 0.1% and MCDEX pereptual trading fee is 0.08%, φ = 0.1% + 0.08% = 0.18%, then APY = α * (γ-2φ) = 0.75 * (20% - 2 * 0.18%) = 14.75%

Downside: If the AMM’s net position is always zero, then γ will decrease to the Base Funding Rate (10.95%). In this case, the APY = α * (γ-2φ) = 0.75 * (10.95% - 2 * 0.18%) = 7.9425%

Inverse Perpetual

There are inverse perpetual contracts (USD-ETH and USD-BTC), which use spot coins (ETH, BTC) rather than the stable coin as collateral. The basis trading of the inverse contract is much easier: Buy the spot coins with all the principal; Use the spot coins as collateral to short the perpetual contract at 1x leverage; No re-margin is needed;

Trading Mining Reward

By trading and holding the short position on MCDEX, traders will have a mining score if he/she stakes some MCB on the platform. As such, the trader will earn an MCB trading mining reward.

Last modified 6mo ago