One of the most innovative and profitable strategies in the crypto space is to create a stablecoin that can generate passive income by exploiting the market inefficiencies of ether futures.
Ether futures are contracts that allow traders to buy or sell ether at a predetermined price and date in the future. They are traded on various platforms, such as BitMEX, Deribit, and FTX. These platforms charge a fee, called the funding rate, to balance the supply and demand of the futures contracts. The funding rate is paid by one side of the trade to the other, depending on whether the contract is trading above or below the spot price of ether.
If the contract is trading above the spot price, it means that there is more demand for long positions than short positions, and the funding rate is positive. This means that longs pay shorts a percentage of their position every eight hours.
Conversely, if the contract is trading below the spot price, it means that there is more demand for short positions than long positions, and the funding rate is negative. This means that shorts pay longs a percentage of their position every eight hours.
The funding rate can vary significantly depending on the market conditions and the platform. For example, on February 20th, 2024, the funding rate on BitMEX was 0.75% per eight hours, which translates to an annualized rate of 821%. This means that if you shorted one ether contract worth $10,000, you would earn $75 every eight hours, or $8210 per year.
Now, imagine that you create a stablecoin that is pegged to the US dollar and backed by a pool of ether. You can use this pool of ether to short ether futures contracts on various platforms and collect the funding rates. You can then distribute these profits to the holders of your stablecoin as yield. This way, you can create a stablecoin that not only maintains its peg to the dollar, but also generates a high return for its users.
This is exactly what some projects in the crypto space are doing. For example, Yield Dollar (YLD) is a stablecoin that earns yield by shorting ether futures and capturing funding rates – which have surged in the past two weeks due to the high volatility and bullish sentiment in the market. According to its website, YLD has generated an average annualized yield of 45% since its launch in January 2024.
Of course, this strategy is not without risks. The main risk is that the price of ether rises significantly and exceeds the liquidation price of the short positions. This would result in a loss of collateral and a devaluation of the stablecoin.
To mitigate this risk, YLD uses a conservative leverage ratio of 2x and monitors the market conditions closely. It also allows users to redeem their YLD tokens for ether at any time, which creates an arbitrage opportunity if YLD deviates from its peg.
Another risk is that the funding rates turn negative and erode the profits of the strategy. This could happen if the market sentiment shifts from bullish to bearish and more traders want to short ether than long it. To hedge against this risk, YLD diversifies its portfolio across different platforms and timeframes and adjusts its positions accordingly.
Creating a stablecoin that earns yield by shorting ether futures and capturing funding rates is a clever and lucrative way to take advantage of the market inefficiencies of crypto derivatives. However, it also involves significant risks that require careful management and constant monitoring. As always, do your own research before investing in any crypto project.
