**1. Basic concepts and principles of capital rates: the "balanced tax"

and "red envelope" mechanism of the currency circle**

1.1 What is a perpetual contract?

In the financial market, arbitrage opportunities between spot and futures markets are not uncommon, and participants can all get involved from large hedge funds to individual investors. However, in the 24-hour uninterrupted trading environment of the crypto market, a special derivative - a perpetual contract was born.

Perpetual contract vs. The core differences between traditional futures contracts:

• No delivery date: There is no delivery date for a perpetual contract. Users can hold positions for a long time without sufficient margin and no liquidation.
• Funding rate mechanism: anchor the spot price through funding rate, so that the contract price is consistent with the spot index price for a long time.

In terms of pricing mechanism, perpetual contracts adopt a dual-price mechanism:

• Mark price: used to calculate whether a position is inflated, determined by the spot weighted average price of multiple exchanges to prevent a single platform from manipulating the market.
• Real-time transaction price: The actual transaction price in the market determines the user 's opening cost.

Through the capital rate mechanism, perpetual contracts can maintain long-term market equilibrium without delivery dates.

1.2 What is the capital rate

Funding Rate is a mechanism used in perpetual contracts to regulate market long and short forces. Its core purpose is to make the contract price as close as possible to the spot price.

In specific calculations, the capital fee rate consists of a premium part + a fixed part. The so-called premium refers to the degree of deviation between the real-time transaction price of the contract and the spot index price.

• Premium Rate = (Contract Price - Spot Index Price) / Spot Index Price
• Fixed interest rate = basic fee rate set by the exchange

When the capital rate is positive, it means that the contract price is higher than the spot price and the bull market is too strong. At this time, the bulls need to pay the capital rate to the bears to curb the bulls' excessive optimism.

When the capital rate is negative, on the contrary, the bears need to pay fees to the longs to curb the bears' excessive pessimism.

Fund rate settlement cycle: Generally, settlement is once every 8 hours, that is, users who hold contracts during each settlement cycle need to pay or charge the fund rate.

1.3 How to understand the funding rate mechanism of perpetual contracts

in a popular way

The funding rate mechanism of perpetual contracts can be compared to the rental market:

• Tenant (Long) = Investor who purchases a perpetual contract
• Landlord (short) = Investor who shorts the perpetual contract
• Area average price (marked price) = average price in the spot market
• Actual price for renting a house (real-time price for contracts) = market transaction price for perpetual contracts

For example:

If there are too many tenants (longs) and the rent (contract price) is speculated to exceed the average market price (marked price), then the tenant needs to pay a red envelope (funding rate) to the landlord to let the rent fall.

If too many landlords (shorts) lead to lowering of rent, then the landlord needs to pay red envelopes to the tenant to make the rent rise.

In essence, the capital fee rate is the dynamic balance adjustment tax of the market, which is used to punish the party that "destroys market equilibrium" and reward the party that "corrects market equilibrium".

**2. Capital rate arbitrage strategy: three methods, but the sources of

returns are consistent**

2.1 Financial Explanation of Fund Rate Arbitrage

The core of capital rate arbitrage is: by hedging spot and contract positions, locking in capital rate returns, and avoiding the risk of price fluctuations. The basic logic includes:

• Rate direction judgment : According to long and short forces, when the capital fee deviates significantly, there is a large arbitrage space
• Risk hedging : offset the risk of price volatility through reverse positions in spot and contracts, and earn only the capital rate
• High-frequency compound interest : settlement every 8 hours, the compound interest effect is significant

In essence, capital rate arbitrage is a Delta-Neutral Strategy, which is to lock in a specific income factor (capital rate) without bearing the risk of price direction.

2.2 Three methods of capital rate arbitrage

1) Single currency single exchange arbitrage (most common)

Specific operation steps:

a. Judgment direction: If the capital fee rate is positive and long pays the fee, it is suitable to short the contract and long spot.

b. Establish a position: short the perpetual contract + long the spot

c. Charging rate: Assuming the spot price of the subject matter increases, the short contract in the combination will be damaged, and the profit and loss of the two will be offset, but the long futures contracts will need to pay you a capital fee to earn capital fee income.

2) Cross-exchange arbitrage for single currencies

Specific operation steps:

a. Scan the exchange's capital rate: Choose two exchanges with sufficient liquidity and large differences in capital rate rates.

b. Establish a position: short perpetual contract (Institution A) + long perpetual contract (Institution B)

c. Earn the difference in capital fee: Earn the difference according to the different capital fee rates on the exchange

3) Multi-currency arbitrage

Specific operation steps:

a. Choose a highly related currency: that is, a currency with a high trend direction, use capital rate differentiation, and hedge directions through position combinations to earn profits.

b. Establish a position: short the high capital rate currency (such as BTC) + long the low capital rate currency (such as ETH), adjust the position according to the proportion

c. Earn income: capital rate difference + volatility income

Among the above three methods, the difficulty increases in sequence, and in actual practice, most of them are the first. The second and third types have extremely high requirements and technical difficulties for execution efficiency and transaction delay. On the basis of the above, leverage can also be added for enhanced arbitrage, but this requires higher risk control and higher risks.

In addition, on the basis of capital fee arbitrage, there are also some more advanced practices, such as combining spread arbitrage and maturity arbitrage to enhance returns and improve capital use efficiency. Spread arbitrage refers to arbitrage using the price difference between the same subject matter (spot and perpetual contracts) on different exchanges. When the market fluctuates greatly or the liquidity distribution is uneven, fund rate arbitrage can be combined with price spread arbitrage to further increase the strategy's rate of return; term arbitrage refers to arbitrage using the price difference between perpetual contracts and traditional futures contracts. The fund rate of perpetual contracts changes with market sentiment, while traditional futures contracts are delivery contracts, so there is a certain price spread relationship.

In short, no matter which hedge arbitrage method is, it is necessary to hedge the full risk of price fluctuations, otherwise the returns will be eroded. In addition, costs need to be considered: such as handling fees, borrowing costs (if leveraged operations), slippage, margin occupation, etc. As the overall market matures, the returns of simple strategies will decline, and it is necessary to combine algorithm monitoring, cross-platform arbitrage and dynamic position management to continuously make profits; the more advanced arbitrage + price spread model has high requirements for transaction execution efficiency and market monitoring capabilities, and is suitable for institutional investors or quantitative trading teams with certain technical capabilities and risk control systems.

**3. Institutional advantages: Why are retail investors "visible but

unable to eat"? What is the reason?**

Fund rate arbitrage seems logically simple, but in practice, institutions have established huge advantages with technical barriers, scale effects and systematization.

3.1 Opportunity identification: dimensionality reduction strikes on speed

and breadth

Institutions use algorithms to monitor the capital rate, liquidity, correlation and other parameters of tens of thousands of currencies in the market in real time, and identify arbitrage opportunities in milliseconds.

Retail investors rely on manual or third-party tools (such as Glassnode) to only cover hourly lag data and focus on a few mainstream currencies.

3.2 Opportunity Capture Efficiency: Cost Dividend Beneath Technology and

Transaction Volume Differences

Under the huge advantages of the entire technology system and cost control, the arbitrage income gap between institutions and retail investors may be as high as several times.

3.3 Risk control system: system-level risk response and artificial game

From the overall risk control perspective, institutions have a mature system for controlling position risks, which can operate in a timely manner when extreme situations occur, and can optionally adopt measures such as reducing positions and supplementary insurance to reduce risks. However, retail investors do not respond in a timely manner and have limited means when extreme situations occur. It is mainly reflected in the following differences:

a. Response speed: The response speed of the mechanism is at milliseconds, and the individual is at least in seconds. When the focus is not tight, it is even at minutes and hours. It is difficult to ensure rapid response.

b. Risk control and disposal accuracy: Institutions can reduce the positions of certain currencies to a reasonable level based on accurate calculations, or choose to supplement margin to a reasonable range, and dynamically adjust to ensure that no risks occur; while individuals lack the ability to accurately calculate and operate, so they can only choose market price closed positions.

c. Multi-currency treatment: When risks occur and need to be dealt with, institutions can handle at least dozens or hundreds of currencies at the same time, and minimize the operational loss of each currency; at most individuals can only handle single-digit currencies in sequence, single-thread.

4. The outlook of arbitrage strategy is adapted to investors

4.1 Differences in institutional arbitrage strategies and market caps

Most people have a question: if institutions adopt arbitrage, will the capacity of this market support and will the profit be reduced. In fact, there are obvious "sameness" between institutions in the entire logic.

Datong: The same type of strategy, such as arbitrage, has roughly the same strategy ideas;

Xiaoyi: Each institution has its own strategic preferences and unique advantages. For example, some institutions prefer to make big currencies and dig deep into opportunities for big currencies; some institutions prefer to make small currencies and are good at currency rotation.

Secondly, from the perspective of market capacity upper limit, arbitrage strategies are the most powerful stable return strategies in the market, and their capacity depends on the overall liquidity of the market; roughly estimated that the current overall arbitrage capacity exceeds 10 billion. However, this capacity is not fixed, but forms a dynamic balance with liquidity growth, strategy iteration, and market maturity. Especially with the rapid growth of the crypto derivatives platform, it will bring about the growth of the entire arbitrage space.

Despite competition among institutions, due to subtle differences in strategies, different currencies and different technical understandings, the yield will not be significantly lowered under the current capacity.

4.2 Investor adaptation

As long as there is a mature risk control system for arbitrage strategies, the risk is usually very small and generally there are very few drawdowns. For investors, the opportunity cost of relative returns is mainly borne by the opportunity cost of relative returns: during periods of relatively sluggish market trading, arbitrage strategies may be at low returns for a long time; when the market is good, the explosive returns are usually not as explosive as trend strategies. Therefore, arbitrage strategies are relatively more suitable for stable investors.

In terms of advantages, low volatility and low retracement, bear markets can become a safe haven for funds and are more favored by risk aversion and stable funds, such as family offices, insurance funds, mutual funds, and high net worth personal wealth allocation.

In terms of disadvantages, the upper limit of returns is not as good as that of trend strategies, and the annualized arbitrage strategy is from 15%-50%; it is lower than the upper limit of returns of long strategies/trend strategies (theory can be 1 to several times).

For ordinary novice retail investors, personal practical arbitrage is an investment of "low returns + high learning costs" and has a poor risk-return ratio. It is also recommended to participate in indirectly through institutional asset management products.

Fund rate arbitrage is the "deterministic return" of the crypto market, but the gap between retail investors and institutions is not in their perception, but the disadvantages of "technology, cost and risk control" are too obvious. Instead of blindly imitating, it is better to choose transparent and compliant institutional arbitrage products and use them as the "ballast stone" of asset allocation.

Disclaimer

This document is for internal reference only by 4Alpha Group and is based on the independent research, analysis and interpretation of existing data by 4Alpha Group. The information contained in this document is not investment advice and does not constitute an offer or invitation to purchase, sell or subscribe to any financial instruments, securities or investment products in the Hong Kong Special Administrative Region, the United States, Singapore or other countries or regions where such offer is prohibited. Readers should conduct due diligence on their own and seek professional advice before contacting us or making any investment decisions.