Crypto carry trade: what are we talking about?

The carry trade is an old strategy, born on the foreign exchange market. You borrow a currency with a low interest rate, invest in one with a higher rate, and collect the difference as long as the exchange rate does not move too much. In crypto the principle is the same, but the income does not come from a central bank. It comes from the funding rate that traders of perpetual contracts exchange with each other.

A perpetual contract is a future with no expiry date. To keep it close to the spot price, the exchange organises a regular transfer between long and short positions. When the market is bullish and buyers pay dearly for the right to be long, they are the ones paying the sellers. That rent is what the carry trade comes to collect.

An academic study on Binance data from 2020 to 2022 documents high, low-volatility returns for this trade, and explains them through buyers' demand for leverage. It describes a past that is gone, not a promise for what comes next.

The delta-neutral setup, in two legs

The simplest version is called cash and carry: buy spot, sell the perpetual short.

Example with bitcoin at 60,000 dollars:

  • you buy 1 BTC on the spot market, so 60,000 dollars of notional;
  • you simultaneously sell 1 BTC of perpetual, so 60,000 dollars of notional.

Your exposure to price is now zero. Bitcoin rises 5 percent: the spot leg gains 3,000 dollars, the short loses 3,000 dollars. It falls 5 percent: the reverse happens. The sum of the two positions no longer depends on market direction. This is called a delta-neutral position, or a market-neutral position.

Two details separate a correct calculation from an illusion:

  • you match notional, not cash posted. A 60,000 dollar perpetual position does not require 60,000 dollars of margin, but it is indeed 60,000 dollars of exposure that must be hedged;
  • both legs must be opened at the same time, on the same asset. A delay of a few minutes already creates a price gap, and therefore a loss from the start.

The funding rate, engine of the yield

The funding rate is the periodic payment between longs and shorts. It is positive when the perpetual trades above spot: longs pay shorts. It is negative when the perpetual trades below: shorts pay longs.

On Binance, standard settlement happens every 8 hours, at 00:00, 08:00 and 16:00 UTC. The formula combines a fixed interest rate of 0.01 percent per 8-hour period, or 0.03 percent per day, with a premium index, and a clamp that limits the adjustment to plus or minus 0.05 percent. Other platforms settle more often: Kraken perpetuals in Europe move to hourly settlement, and Binance also switches to an hourly rhythm when a contract reaches its funding cap.

The practical consequence: a displayed rate is not an annual rate. You have to put it back into its settlement interval before comparing anything.

Calculating the real return, not the dream return

Take a funding rate of 0.01 percent per 8 hours, three settlements per day. That is 0.03 percent per day on notional, or about 10.95 percent per year if the rate stayed identical for 365 days. That figure is a multiplication, not a promise: the rate changes, sometimes several times a day.

The calculation does not stop there, fees have to come out. Kraken gives a useful example: with funding at 0.05 percent per 8-hour period on 60,000 dollars, the short collects 90 dollars per day. If the round trip on both legs costs 0.04 percent of notional, or 24 dollars on 60,000, about 66 dollars per day remain. At the base rate of 0.01 percent, entry and exit eat a much larger share of the income: at 18 dollars per day, the carry no longer covers its costs.

Three calculation mistakes come up again and again:

  • quoting an annual return from the rate of the moment;
  • forgetting the fees on both legs, at entry and at exit;
  • comparing funding to total capital when it is calculated on notional.

How much capital is tied up?

A delta-neutral position ties up capital twice: the spot purchase on one side, the margin for the short on the other. If you cover the short with 100 percent margin, your return on total capital is roughly half the return calculated on notional. Many traders use moderate leverage on the short leg to improve that ratio, which brings the liquidation price closer. The trade-off is direct: more leverage, better return on capital, less room to manoeuvre if the market rises fast.

A carry should therefore not be judged on the funding rate alone, but on the net return relative to the capital actually tied up, fees and margin buffer included.

The variants: basis trade and funding arbitrage

Cash and carry on perpetuals is not the only form of crypto carry.

The basis trade uses a dated future. You buy spot and sell a contract with an expiry that trades at a premium. At expiry the two prices converge and the premium is collected. The advantage is that the return is largely locked in at entry. The drawback is that you have to wait for expiry, and the premium compresses when too much capital crowds into the same trade.

Cross-exchange funding arbitrage means selling the perpetual where funding is highest and buying where it is lowest. The income is higher, but you double the counterparty risk: two platforms can fail, and funds have to be moved between them.

When funding turns clearly negative, the setup reverses: long perpetual, short spot. Except that selling spot means borrowing the asset, at a cost that can exceed the funding collected. That version is far less accessible to individual investors.

The invisible costs

A carry is won or lost on execution details: maker versus taker fees, spreads, account funding costs, withdrawal fees, stablecoin conversions. A badly executed round trip can wipe out several weeks of funding, especially on pairs where the rate is low.

Time counts too. Two legs to monitor, margin to top up when the price rises, rates that change, decisions to make when funding goes below zero. A carry run by hand on a spreadsheet quickly becomes a source of errors. Serious setups automate entry, margin monitoring and exit, or set the closing rules in advance.

What the carry is not

It is not a savings account. Nobody guarantees the yield, it depends on a rate the market sets continuously. It is not a placement decorrelated from everything either: it remains exposed to the health of the platforms, to liquidity and to stablecoins. Finally, it is not a disguised directional strategy. If you keep a long or short bias, you are no longer running a carry, you are making a price bet with side income.

The liquidation risk on the short leg

This is the most misunderstood risk, and the most dangerous. A globally neutral position can lose money on a single leg. If bitcoin rises sharply, the short perpetual loses, even though the spot leg gains on the other side. Spot does not automatically serve as margin for the short: these are two accounts, sometimes two separate balances. If the short's margin runs out before you top it up, the platform liquidates the short leg and you are left with unhedged spot exposure, at the worst possible moment.

The other structural risks:

  • funding reversal, which turns income into a cost;
  • basis risk, when the perpetual trades at a discount at exit;
  • counterparty risk, since a platform is not a bank and deposits are not guaranteed;
  • stablecoin risk, if the settlement asset loses its peg;
  • operational risk, one leg closed and not the other.

Before opening a position: the checklist

  • Has funding been positive for several days, and not just right now?
  • What is the net return after fees, relative to the total capital tied up?
  • At what price would the short be liquidated, and is that price far from the market?
  • How much margin can you add if the price rises 20 percent in one day?
  • What exit rule do you apply if funding turns negative for a week?

The risks, plainly

The crypto carry trade is not a risk-free yield. It is income paid for carrying specific risks: funding variation, liquidation of an isolated leg, basis, counterparty, stablecoin, execution. These risks are invisible when everything is calm, and they often show up together during stress. A past return, a backtest or a screenshot of gains says nothing about the next rate reversal. Before committing capital, check that you can name every risk and quantify the maximum loss you accept, including the loss of an entire leg. None of the above is personalised investment advice.

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