This post will shed some light on what basis trading is and how Vortex, Akropolis’ upcoming basis trading product applies it in DeFi.
Tl;DR — Vortex efficiently manages strategy positions to collect and compound the Funding Rate from Perpetual Contracts while remaining market-neutral. Low maintenance, low(er) risk and high(er) reward — with Vortex you’re GMI.
Crypto Cash and Carry Strategy Explained with Example
Basis trading, also known as ‘cash and carry’, is a market-neutral arbitrage strategy that leverages the difference between the spot and future price of a commodity (the ‘basis’).
While TradFi and DeFi approach basis trading differently based on the available infrastructure and liquidity, both use similar market mechanisms to achieve their returns.
What is Cash and Carry Method in TradFi?
Basis trading in the TradFi world involves taking advantage of the difference between a commodity’s spot price and its future price – on centralized futures markets.
Ethereum (ETH) Basis Trading Example
Let’s suppose ETH is trading at $3500 at spot market and the December 31 futures contract is trading at $4000. There is a $500 price differential (the basis) between these two prices – this is known as being in ‘contango’.
- The trader in this scenario would:
- Purchase 1 ‘physical’ ETH at the spot price of $3500
- Sell 1 ETH worth of the futures contracts at $4000
In total, the trader has paid $7500 for these positions.
- Now, fast forward to December 31st — where ETH is now trading at $4500 — the trader has:
- Gained $1000 on their physical ETH
- Lost $500 on their futures contract
Resulting in a gross profit of $500, which is the basis.
- What if the price of ETH on December 31st is below $3500 ? Let’s say the price is $3000. In that case, the trader has:
- Lost $500 on their physical ETH
- Gained $1000 on their futures contract
Again resulting in a gross profit of the basis: $500.
Currently, there are no on-chain futures markets on Ethereum that utilize this traditional basis trading model. As a fully on-chain strategy, Vortex utilizes a similar structure but brings in DeFi innovation.
Vortex — Futures Basis Trading in DeFi
In place of a centralized futures market, Vortex uses decentralized derivative exchanges that offer ‘Perpetual Contracts’ to generate yield.
What are Perpetual Futures Contracts in Crypto?
Perpetual Contracts are similar to traditional futures, except that they have no expiration or settlement date. They continue perpetually until the position is closed.
Due to their indefinite-until-closed nature, Perpetuals tend to trade closer to spot prices than futures, but, being derivatives, they do still diverge. In general, price divergence from spot reflects the sentiment of traders at the exchange.
It is crucial to manage this divergence and close the gap between spot and perpetual prices frequently.
The mechanism to achieve this control and incentivize spot/Perpetual price stability is known as the ‘Funding Rate’.
What is the Funding Rate in Crypto Perpetual Futures?
Funding Rate refers to a fee periodically paid from the ‘more popular’ side of the market to the opposing ‘less popular’ side of the market to encourage contract purchases.
When the Perpetuals price is higher than the spot price, the Funding Rate will be positive and traders with open long contracts will pay the rate to traders with open short contracts.
Conversely, when the Perpetuals price is lower than the spot price, the Funding Rate will be negative and open shorts will pay open longs.
How Vortex applies Basis Trading?
The crypto markets have historically favored longs because most participants believe that prices will go up.
Decentralized derivatives exchanges that offer perpetual contracts have continued to demonstrate this trend, meaning that Funding Rates have historically, on average, been positive. Therefore, from a Funding Rate perspective, it has been profitable to open short positions – but if prices suddenly moon, you may lose a lot more than your Funding Rate returns.
Vortex eliminates the directional risk associated with short positions while maintaining the Funding Rate advantage, allowing users to generate market-neutral yields.
Here’s a high-level example of how Vortex works in favorable conditions:
- User deposits 7000 USDC into Vortex, receiving a proportionate share of the vault as Vortex vault tokens.
Assuming 1 ETH = 3500 USDC, Vortex’s underlying strategy will then:
- Send 3500 USDC to a DEX to buy 1 ‘physical’ ETH;
- Send 3500 USDC to a derivatives DEX and use it as collateral to short 1 ETH worth of perpetual contracts.
- Vortex will automatically collect the funding rate and periodically compound and rebalance into both positions, increasing the value of the vault tokens.
Why use Vortex for cryptocurrency yield?
Overall, you should use Vortex for the following reasons:
- Market-Neutral — By using Vortex, you can generate sustainable high yields without being exposed to the risk of crypto-versus-fiat prices.
- Lower Risk, Higher Reward — A proven alternative to lending or farming with stablecoins, Vortex is profitable regardless of market conditions.
- Low Maintenance —For users, Vortex presents a passive “set and forget” strategy, with periodic compounding to further increase returns.
At the same time, providing the liquidity that is necessary for Perpetual Contracts to function. Using Vortex means WAGMI.