Delta Neutral BTC Trading Algorithm

Normally bitcoin sits theres doing nothing but appreciating in value as the adoption rate increases and the cypherpunks continue to build out the features and use cases for this wonderful piece of tech.

But here’s a strategy for generating yield on your bitcoin in a relatively low-risk way. It involves taking advantage of the funding rates paid out to Bitcoin futures traders that sell or buy contracts that are at odds with the market. When the futures price is trading below the spot price, longs pay shorts and vice versa.

Betting against the market pays dividends via the funding rate, but naturally incurs some risk. Shorting Bitcoin futures when the market is bullish is a high risk play. So how can one use this asset to generate yield without exposing themselves to the possibility of significant losses?

Well hedging futures trade on the spot market is one way. Essentially if the funding rate is positive (so longs are paying shorts) then you can buy bitcoin on the spot market, and sell an equivalent amount of Bitcoin in futures contracts to arrive at a ‘delta neutral’ position. You can now collect the funding rate yield, and if the price moves to the upside, the value you lose on the contracts are hedged by the assets your own on the spot market.

When the sentiment shifts, you can close your futures position and sell your Bitcoin in a spot trade and then rebalance your holdings (so the funds you hold in your futures wallet equals those in your spot wallet). Then you can do the reverse of your initial trades, that is sell Bitcoin on the spot market and go long in the futures market, once again reaching a delta neutral position. Continue collecting yield from a negative funding rate (where shorts pay longs) until there is another shift.

Using this method you are always generating yield from at least some of your assets (those locked into futures contracts) and your trades are fully hedged against any market volatility. In fact you benefit from it. When there is high market volatility, the likelihood that the spot price is significantly lower or higher than the current perpetual futures index prices, and therefore the funding rates (used to incentivise the price gap to close) will be higher — netting you more yield from your assets.

So what are the drawbacks to this method? Well any fully hedged trade suffers from the fact that you don’t gain directly from the price moving. The only caveat to this is that since payouts are delivered in BTC (at least on the Kraken futures market) you will want the price of Bitcoin to rise over the long term (a fairly safe bet). Still, when there is a significant price increase for Bitcoin, the fact you hold 50% cash as a hedge, means you’ve lost out on potential gains (opportunity cost is a bitch).

So long as you understand that (and have a decent stack of sats that will benefit from number-go-up) this is a simple way to generate more Bitcoin from your Bitcoin. The strategy is also so straight forward that it could be automated simply, and would result in a fairly lucrative passive income stream.

In a future post I will outline a proof of concept, with code, demonstrating how to create a trading bot that utilises this strategy. Since we’re currently in a very sideways market, with a great deal of uncertainty in the very near future — I would recommend these kind of low risk trading strategies instead of the leveraged long/short trades we so often see being liquidated en masse.

Peace.