What is a Carry Trade in Crypto?
A carry trade is a relatively low-risk, market-neutral trading strategy that allows traders to profit from price differences, or spreads, between an asset's spot price and its corresponding futures or perpetual-swap contract price
1. This strategy is a form of arbitrage
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The core principle of a carry trade is to take two simultaneous, opposite positions of the same quantity, making the strategy "market neutral"
1. This means the trader's profit does not depend on the direction the underlying asset's price moves
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How a Crypto Carry Trade Works
A standard carry trade involves two legs
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- Long Spot Position (Borrowing/Buying): The trader buys the crypto asset in the spot market 1.
- Short Futures/Perpetual Swap Position (Lending/Selling): Simultaneously, the trader sells a futures contract or perpetual swap for the same quantity of the asset 1.
The profitability of the strategy relies on the fact that futures contracts are often priced above or below the spot price
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Contango and Backwardation
- Contango: When the spot price is below the futures price, the market is in contango, and a standard carry trade (long spot, short futures) will often result in profits 1.
- Backwardation: When the opposite is true (spot price is above the futures price), the market is in backwardation, and a reverse carry trade (shorting in the spot market and longing the futures contract) is the more favorable strategy 1.
Profit Mechanism
In a futures-based carry trade, the profit is essentially known from the start
1. The strategy relies on the natural convergence of the spot and futures prices as the settlement date approaches
1. The trader looks for the widest possible spread between the two prices at entry
1. By settlement, the two prices will have converged, and the trader can close both positions for a profit equal to the original difference, provided the spread is narrower than it was at entry
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For example, if a trader buys 1 BTC for 25,000 USDT (spot) and simultaneously shorts a futures contract agreeing to sell 1 BTC for 25,200 USDT, the 200 USDT difference is the potential profit, regardless of whether the BTC price rises or falls by the settlement date
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Carry Trades with Perpetual Swaps
When using perpetual swaps, the price does not converge with the spot price in a predictable manner because perpetuals do not have a defined settlement date
1. In this case, a trader profits from
positive funding rate payments by keeping the position open as long as the perpetual swap price remains above the asset’s market price
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Attractiveness and Risks
Carry trades are attractive because they are a straightforward way to lock in profits from price discrepancies without requiring the trader to predict the asset's price direction
1. The volatile and sometimes inefficient nature of crypto markets can present more attractive carry trade opportunities than those found in more established markets
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However, executing a carry trade manually carries
execution risk, as there is a chance that only one leg of the trade will fill, especially in volatile markets
1. Platforms often offer block trading features to mitigate this risk by enabling the simultaneous execution of both trade legs
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Real-World Impact
The unwinding of carry trades can have a significant impact on market volatility
2. For instance, a strengthening currency (like the Japanese yen) can make borrowing more expensive, leading traders to sell risk assets, such as Bitcoin, to close their yen-based carry trade positions
2. This rush to close positions can lead to cascading liquidations and downward pressure on crypto prices
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