Spot Perpetual Arbitrage: Simplified

Imagine you’re someone who buys apples from two sources: the local farmers’ market, and an online grocery service that delivers apples on a future date at a specific price.

If the apples are cheaper at the farmers’ market than the online store, you can buy them from the farmers’ market and arrange to sell them to the store on the day of delivery. You're guaranteed a profit as you'll be able to deliver the apples at a higher price than you bought them for.

If apples are cheaper at the online store than at the farmers’ market, you can place a future order for apples at the store and then sell any apples you have at the farmers’ market (borrow if you don’t have). You're guaranteed a profit as you'll be selling apples at a higher price than you bought them for.

If you’ve read our contango blog, you already know that you can’t use this strategy when it comes to perishable assets (like apples and oranges). But in the trading world, you can - it’s called spot perpetual arbitrage; the farmers’ mart represents the spot market and the online store denotes perpetual contracts.

A Closer Look at Spot Perpetual Arbitrage

Spot markets let you buy and sell cryptocurrencies for immediate delivery. Perpetual contracts allow you to trade the price of a cryptocurrency without ever owning it. They have no expiration date, unlike futures contracts.

And spot perpetual arbitrage is a trading strategy that capitalises on price discrepancies between spot markets and perpetual contracts to generate profits.

How Does Spot Perpetual Arbitrage Work?

If the price of a cryptocurrency on a spot market is significantly different from its price on a perpetual contract, an arbitrage opportunity arises. Remember the apple example? Let’s revisit that with BTC - if the spot price of an asset is lower than the perpetual price, you can purchase the asset on the spot market and simultaneously sell a perpetual contract at a lower price.

Advantages and Disadvantages

Pros

• Risk-free profit: When executed correctly, spot perpetual arbitrage can offer risk-free profit opportunities

• Quick returns: Arbitrage opportunities can be executed quickly, allowing for rapid profit generation.

• Diversification: It can diversify a trading portfolio, providing potential returns unrelated to market movements.

Cons:

• Transaction costs: Fees associated with trading on spot markets and perpetual contracts can eat into profits.

• Market volatility: Sudden price fluctuations or market disruptions can make it difficult to capitalise on arbitrage opportunities.

• Complexity: Implementing a successful spot perpetual arbitrage strategy may require sophisticated technical infrastructure, including low-latency connections and advanced algorithms.

The Bottom Line

Spot perpetual arbitrage is a complex trading strategy that requires a deep understanding of crypto derivatives and market dynamics. While it can offer lucrative opportunities, it's important to be aware of the risks and challenges involved.