Funding Rate Arbitrage

Table of Contents

1. Introduction

2. Funding Rate Mechanism

3. Funding Rate Velocity Model

4. Market Price Adjustment

5. Funding Rate Arbitrage Guide

6. Risk Management

7. Examples and Calculations

Introduction

Polynomial uses an innovative funding rate mechanism that differs from traditional perpetual exchanges. The system employs a continuous funding rate velocity model combined with dynamic market pricing to create efficient markets and arbitrage opportunities.

Funding Rate Mechanism

Core Concepts

Funding rates in Polynomial serve three primary purposes:

1. Maintain perpetual futures price alignment with the underlying asset

2. Balance long and short positions in the market

3. Create arbitrage opportunities that help maintain market efficiency

How Funding Works

Unlike traditional exchanges that calculate funding at fixed intervals, Polynomial implements a continuous funding rate model where:

• Funding is calculated and applied continuously

• Rates adjust based on market skew

• Payments flow directly between longs and shorts

The basic funding formula is:

Funding Payment = Position Size × Funding Rate × Time Elapsed

Where:

• Position Size is in USD

• Funding Rate is an annualized percentage

• Time Elapsed is measured in years (e.g., 1 hour = 1/8760)

Funding Rate Velocity Model

Polynomial uses a velocity-based approach to funding rate adjustments. Instead of directly setting funding rates based on skew, we adjust the rate of change of funding:

dr/dt = c × skew

Where:
- dr/dt is the funding rate velocity
- c is the velocity coefficient
- skew = (long_positions - short_positions) / skew_scale

This creates smoother funding rate transitions and more predictable arbitrage opportunities.

Key Properties

1. Continuous Adjustment: Funding rates evolve smoothly rather than jumping at fixed intervals

2. Market Memory: The system maintains memory of previous imbalances

3. Path Independence: Total funding is determined by net market imbalance

Market Price Adjustment

Market prices on Polynomial adjust dynamically with skew:

Market Price = Oracle Price × (1 + k × skew)

Where:
- k is the skew sensitivity parameter
- skew = (long_positions - short_positions) / skew_scale

This creates two levels of incentives:

1. Immediate price impact for market balancing

2. Ongoing funding payments for position maintenance

Funding Rate Arbitrage Guide

Basic Arbitrage Strategy

1. Identify Opportunity

   • Monitor funding rates across exchanges

   • Look for significant rate differentials

   • Check liquidity on both venues

2. Position Setup

   • Short on the high funding rate venue (Polynomial)

   • Long on the low funding rate venue

   • Maintain equal position sizes for delta neutrality

3. Capital Requirements

   Required Margin = Position Size × Max(Margin_Rate_A, Margin_Rate_B)
   Buffer Margin = Required Margin × 0.3 (recommended 30% buffer)

Advanced Implementation

1. Entry Execution

   • Use limit orders to minimize slippage

   • Enter positions when funding rate differential exceeds transaction costs

   • Consider gas costs on both venues

2. Position Monitoring

   • Track funding payments

   • Monitor price deviation between venues

   • Watch for changes in funding rates

3. Exit Conditions

   • Funding rate convergence

   • Achievement of profit target

   • Risk threshold breach

Cross-Margin Advantage

Polynomial's cross-margin system provides several benefits for arbitrage:

1. Capital Efficiency

   • Single margin pool for all positions

   • Reduced total margin requirements

   • Better leverage utilization

2. Risk Management

   • Portfolio-wide liquidation pricing

   • Unified collateral management

   • Simplified position tracking

Risk Management

Key Risks

1. Exchange Risk

   • Counterparty risk

   • Platform downtime

   • Oracle failures

2. Market Risks

   • Price deviation between venues

   • Sudden funding rate changes

   • Liquidity gaps

3. Operational Risks

   • Network congestion

   • Smart contract risk

   • Implementation errors

Risk Mitigation Strategies

1. Position Sizing

   Max Position Size = Account Value × Risk Factor / Max Expected Loss
   Where:
   - Risk Factor = 0.02 (2% risk per trade recommended)
   - Max Expected Loss includes potential funding and slippage

2. Margin Management

   • Maintain minimum 25% buffer above liquidation

   • Scale positions based on funding rate volatility

   • Consider correlation between venues

Examples and Calculations

Example 1: Basic Funding Arbitrage

Given:

• Polynomial funding rate: +200% APR

• Other venue funding rate: +10% APR

• Position size: $100,000

Calculations:

Daily funding differential = $100,000 × (200% - 10%) / 365
                         = $100,000 × 1.90 / 365
                         = $520.55 per day

Example 2: Position Sizing with Risk Management

Given:

• Account value: $100,000

• Risk factor: 2%

• Expected worst-case loss: 5%

Max Position Size = $100,000 × 0.02 / 0.05
                  = $40,000

Example 3: Required Margin Calculation

Given:

• Position size: $40,000

• Margin rate A: 5%

• Margin rate B: 10%

• Buffer: 30%

Required Margin = $40,000 × Max(5%, 10%)
                = $40,000 × 0.10
                = $4,000

Total Required = $4,000 × 1.30 (including buffer)
               = $5,200

Advanced Topics

Funding Rate Velocity Implications

The velocity model creates unique properties:

1. Smoother rate transitions

2. More predictable arbitrage opportunities

3. Better market stability

The funding rate velocity can be used to predict future funding rates:

Future_Rate = Current_Rate + (dr/dt × Time)

Where:
dr/dt = c × skew as defined earlier

Market Impact Analysis

When executing large arbitrage positions, consider the market impact:

Expected_Slippage = k × Position_Size / Market_Depth

Total_Cost = Slippage + Gas_Fees + Exchange_Fees

Only execute when:

Expected_Funding_Profit > Total_Cost × Safety_Margin

Conclusion

Successful funding rate arbitrage on Polynomial requires:

1. Understanding of the continuous funding mechanism

2. Proper risk management

3. Efficient execution

4. Constant monitoring

5. Adaptation to market conditions

For the latest parameters and updates, refer to the contracts.

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Note: All formulas and parameters are subject to change. Always verify current values before trading.