Arbitrage Trading: Mechanism and Applications

Arbitrage trading is an investment strategy that allows traders to generate income by exploiting price differences of the same asset across different markets. In the cryptocurrency space, arbitrage trading has developed alongside the expansion of trading platforms and has become one of the main methods to improve capital efficiency for experienced investors.

Today’s cryptocurrency market offers several main types of strategies: spot arbitrage, funding rate arbitrage, and futures arbitrage. Each strategy has its characteristics and requires an understanding of market mechanics.

Main Types of Arbitrage Trading

Arbitrage trading is based on a simple principle — simultaneously buy an asset at a lower price on one market and sell it at a higher price on another. However, practical application of this principle involves understanding several key approaches.

Funding Rate Arbitrage

One of the most popular arbitrage mechanisms is exploiting differences in funding rates between the spot market and the perpetual contract market. The funding rate is a percentage periodically paid by traders holding open positions in one direction (usually longs) to those holding positions in the opposite direction (shorts).

When the funding rate is positive, the strategy looks like this: the trader simultaneously buys the asset (e.g., BTC) on the spot market and opens a short position of the same volume in a perpetual contract. This way, losses from a price decline in the short position are offset by profits in the spot assets, and the trader earns a financial income from the rate difference. This is called “positive arbitrage.”

In the opposite scenario, when the funding rate is negative, the tactic changes: the trader opens a short position on the spot market and a long position in the perpetual contract, allowing profit from the negative rate.

For example, suppose the perpetual BTCUSDT contract has a positive funding rate of +0.01%. If a trader has a margin of 30,000 USDT (equivalent to 1 BTC at the current price), they can:

• Buy 1 BTC on the spot market
• Open a short position of 1 BTC in the perpetual contract

In this case, any fluctuations in BTC price will be neutralized by opposite positions, and the trader will earn only from the funding rate. This approach minimizes market risks and provides stable income.

Price Spread Arbitrage

The second key arbitrage approach involves exploiting the price difference of a single asset between the spot market and the futures market. If the BTC price on the spot market is lower than the futures contract price BTCUSDC, the trader can:

• Buy BTC on the spot market (cheaper)
• Sell a futures contract for BTC (more expensive)

Profit is realized when prices converge, i.e., at the contract’s expiration, the spot and futures prices align. This strategy is especially effective when there is a significant spread between markets.

The spread is calculated by the formula:

Spread = Sale price of the ticker – Purchase price of the ticker

Relative spread value = (Sale price – Purchase price) / Sale price

The annual percentage rate (APR) of the spread is determined as:

APR of the spread = (Current spread / Maximum period in days) × 365 / 2

where the maximum period is the number of days until the futures contract expires.

Tools and Features for Implementation

Modern trading platforms provide specialized tools for executing arbitrage strategies. These tools enable traders to place orders on different markets simultaneously without needing to use APIs.

Monitoring Opportunities

The first step is identifying profitable arbitrage opportunities. Ranking systems display trading pairs sorted by:

• Funding rates — list of pairs in descending order of funding rates, helping identify the most profitable options for earning from funding
• Price spreads — ranking pairs by the size of the price gap between markets, aiding in finding the largest price differences

Synchronized Order Placement

A key feature is the ability to place orders simultaneously on both markets from a single interface. Traders can monitor price dynamics and liquidity in real-time, then confirm both operations with one action. The asset amounts in both directions should be equal, but orders are placed in opposite directions (buy on one market, sell on the other).

Automatic Rebalancing Function

One innovative feature is automatic portfolio rebalancing. The system checks the executed order amounts in opposite directions every 2 seconds. If a mismatch is detected (e.g., 0.5 BTC executed in one direction and 0.4 BTC in the other), the platform automatically places a market order for 0.1 BTC to balance the position.

Rebalancing operates for 24 hours. After this period, all unfilled orders are automatically canceled. This function significantly reduces risk when one part of the order executes much faster than the other.

Arbitrage Trading Execution Process

Practical arbitrage trading involves several steps.

Choosing a Strategy and Asset

The first step is selecting an asset based on funding rates or price spreads. The trader analyzes available pairs and assesses potential profit considering commissions and risks.

Placing Two-Way Orders

After selecting an asset, the trader chooses the direction (long or short) for the first market. The system automatically determines the opposite direction for the second market. Then, the order type is selected:

• Market order — immediate execution at the current market price
• Limit order — execution at a specified price or better

When entering a limit order price, the trader can see an estimated income in the form of the funding rate or spread size.

Managing Positions After Execution

Once the orders are fully executed, the trader receives:

• Assets on the spot market, visible in the spot trading assets section
• Open positions in perpetual or futures contracts, trackable on the derivatives positions page
• Income from funding rates, visible in transaction history and event logs

Closing Positions

The trader is responsible for actively managing positions, which may include:

• Actively closing positions upon reaching target profit
• Transferring assets between markets as conditions change
• Monitoring liquidation risks, especially with partial order fills

Key Aspects and Risks

Additional Opportunities

Arbitrage trading is available when using a unified trading account (ETA), which allows using over 80 different assets as collateral. This means a trader can open arbitrage positions using not only USDT but also other assets accepted by the platform.

Risks and Limitations

Despite the attractive steady income, arbitrage trading carries significant risks:

Disbalance risk of liquidation

If orders are executed unevenly (one market fully filled, the other only partially), a collateral imbalance may occur, risking liquidation. Automatic rebalancing helps mitigate this risk but does not eliminate it entirely.

Slippage and price deviation

With the rebalancing feature enabled, the system places market orders, which can lead to execution price slippage, especially on low-liquidity markets.

Insufficient margin

An order will not be executed if available margin is insufficient to open positions in both directions simultaneously.

Lack of automatic position management

The tool does not provide automatic position closing or management. The trader must monitor and manage each position manually.

Risk Minimization Recommendations

• Enable automatic rebalancing by default to reduce imbalance risks
• Check available margin before placing orders
• Start with small volumes to test the strategy
• Monitor funding rates regularly — they can change, affecting profitability
• Actively manage and close positions upon reaching target levels

Frequently Asked Questions

When is arbitrage trading most effective?

Arbitrage trading is especially effective in scenarios such as:

• When there is a significant spread between trading pairs — the strategy allows locking in short-term profits
• When executing large orders — two-way trading reduces market impact and slippage
• When implementing complex multi-position strategies — the tool ensures synchronized execution

How to calculate potential income?

Funding rate calculations use the formula:

APR of funding rate = (Total funding rate over 3 days / 3) × (365 / 2)

where the total funding rate over 3 days is the sum of all funding rates over the last three days for each interval.

Can the tool be used to close existing positions?

Yes, arbitrage trading allows opening and closing positions in a synchronized manner.

What happens if automatic rebalancing is disabled?

Disabling rebalancing means the system will not automatically adjust the executed order amounts. Orders on both markets will operate independently, increasing the risk of imbalance, especially with partial fills.

What is the period for rebalancing?

Automatic rebalancing operates for 24 hours from activation. After this period, all unfilled orders are canceled automatically, and the strategy ends.

Why didn’t the order execute?

Main reasons include:

• Insufficient available margin in the account
• Lack of liquidity on one of the markets
• Limit order set at a price that was not reached

Solution: adjust the order volume or wait for better liquidity conditions.

How to view the final profit?

After completing an arbitrage trade:

• Assets on the spot market are visible in the spot assets section
• Income from funding rates appears in transaction history (event log)
• Open derivative positions are visible in the derivatives positions section

Arbitrage trading remains an effective tool for experienced traders seeking to monetize price differences between markets. Success depends on a deep understanding of market mechanics, careful risk management, and continuous monitoring of positions.