How to make income flywheel on perpetual exchanges.

Feb 22, 2024

Part 1. The Blueprint: Setting Up Your Income Flywheel

The hype around earning from funding rates on perpetual DEXs is currently gaining momentum. There's a lot of noise around the Ethena project, although in reality, they've simply packaged a fairly simple strategy into a wrapper and presented it as a stablecoin. It's an original presentation but inside is a rather risky structured product, and after reading this article, you'll understand the nuances of how such a strategy works and what is most important in it.

Unlike Ethena, which will pay about 20% income and take the rest for itself, you will receive all the income and, in the end, get an upgraded wallet with passive income, which will feed you if you put in a little effort.

Alright, let's dive in.

Setting up a delta-neutral play on two different DEXs. I'm rolling with BTC 'cause it's chill on the volatility front (compared to other assets). This way, I'm earning less but sleeping tight, plus saving on those nasty rebalancing fees. And yeah, with those high-volatility tokens, you could easily see half your deposit vanish with one wild swing. BTC's way safer in that regard.

Such spikes on volatile altcoins are common and can be devastating to your deposit.

So, you pop open two equal positions across different DEXs, going short on one and long on the other. You gotta get savvy with how funding rates work, though. In simple terms, if funding rates are positive, longs are paying shorts, and vice versa. So, you wanna short where the funding rate's higher and go long on the other DEX where it's lower (ideally, they are negative). The goal with funding rate arbitrage is to at least cover the costs like fees and spreads. The exchanges should hit you up with their tokens, which you can gradually stack and stake - that's gonna be one of your passive income streams.

Part 2. Engineering Your Strategy for Sustainable Earnings

Naturally, the toughest part of this setup is finding perp DEXs that tick all the boxes, and there are quite a few requirements, some of which I'll list:

The exchange needs to be profitable, rewarding its traders and investors, and should reinvest a portion of these earnings into technical development. Without constant innovation in this field, competitors will quickly overtake you (look at Level Finance).
Good tokenomics - the exchange should reward its token for trading and other activities (holding positions long-term, staking, various incentives & partnership rewards & other events) on the platform, and share profits through the token (ideally in stablecoins). Through token staking, the platform should primarily reward the most loyal (long-term) stakers, and weak hands should be penalized (ideally to the benefit of long-term investors).
Funding fees should offer a good delta through arbitrage and ideally be inversely correlated. Good liquidity also plays a big role here, so buying a single BTC doesn't affect the funding fee (unfortunately, most DEXs fall short on this metric).
Low fees or some form of compensation for these fees.
Ideally, working DEXs should be on the same chain to avoid losing time and fees on bridges when rebalancing positions. I spent some time working with Arbitrum + Solana, and it was a pain and suffering + different wallets Phantom & Rabby.
A clear and user-friendly interface - oh, how many DEXs are ruled out just because of a poorly thought-out and flawed interface.

Currently, I consider Vertex + HMX DEXs that best meet all criteria. Both exchanges have a good stable income and are constantly developing their technologies and tokenomics.

The tokenomics of both projects, although based on rewarding users through token issuance, have mechanisms to offset token inflation with long-term staking.
HMX rewards for holding an open position, while Vertex automatically accrues income (often double-digit) on your capital on the platform. This is a distinguishing feature of these two exchanges.
There are also significant nuances like per-block funding fee accruals, which HMX has but many other exchanges lack. That is, on HMX, you earn income from Funding rates every second, while on other exchanges, it's only at the end of each hour. So, if a position is closed at 59 minutes, you get nothing. Might sound like a minor detail, but I've lost this income many times because I had to close a position for rebalancing, and the hourly income was at 0.01%, which equates to roughly 100% APR.
The funding rates on these exchanges are pretty stable, smoothly changing, and rarely correlated.
Both exchanges aren't at the very top, which means there's less competition for rewards here (especially on HMX) compared to, say, what's currently happening in Drift or Hyperliquid.

Part 3. Advancing and Sustaining Your Income Flywheel

But, of course, these exchanges have their downsides:

Vertex has a low maximum leverage of x20. I consider the ideal leverage to be around x35, in which case we can open a position on 1 BTC for every $1500, and we have about 5% margin in both directions before liquidation. And HMX has high fees.

And now about the competitors.

The Perp DEX sector in crypto is very dynamic, and of course, you can't just pick 2 exchanges and stick with them forever, never to leave. It's entirely possible that HMX and Vertex could fade into the background in light of more appealing exchanges popping up, forcing a decision to switch. In such a case, you'd either need to start anew on new exchanges or sell your accumulated tokens and move your capital elsewhere. With HMX, this could be problematic since there's a minimum 1-year vesting for tokens, so keep that in mind.

Besides, you'll always experience FOMO for potentially missing out on larger airdrops from trading on non-token-based exchanges. However, I advise using another portion of your capital for such purposes. In this strategy, we opt for guaranteed cash rewards over the promise of token airdrops with unknown tokenomics.

So, which exchanges might pose competition to my choices of Vertex & HMX in the near future ?

IntentX

From a tokenomics standpoint, it's an ideal candidate, but the exchange is still too small and technically awkward. No surprise there, as the project is trying to do something unique. I'll definitely keep an eye on it, but in its current state, it doesn't fit my needs.

Hyperliquid

Quite a controversial exchange. On one hand, it's currently the most popular exchange by popularity and trading volume. On the other, nobody knows who owns it, where its funding comes from, as investment details are undisclosed. The project doesn't share its financial state or tokenomics details, and with the end of their points event not far off, it would be nice to know what we're fighting for by burning commissions. Additionally, the project often faces FUD due to uncertainties about its continuity. Technically, the exchange functions perfectly for a young project.

Drift

The exchange probably has the widest functionality, including perps & spot & swaps for traders and various liquidity provision earning solutions. However, I have questions regarding their incentives.

First, their Drift draw is a rather poor lottery rather than a way to reward loyal platform users.

Second, they launched a points system that will last for 3 months, after which an airdrop is promised. The points campaign initially had specific conditions for distributing 2M points weekly based on activity, but not two weeks in, the conditions began to change, introducing campaigns like x8 points for trading BTC & ETH over a week, which will make whales richer at the expense of distributing points from small to large banks, which isn't exactly fair.

Whether this exchange becomes a top not only on Solana will entirely depend on their future tokenomics, and Drift's ability to implement various incentives raises big questions.

I must also mention projects like Vela, Holdstation, WooFi. These projects are technically attractive but have serious issues with tokenomics, commissions, and incentives for traders. These projects operate on the principle of "You buy our token, pay us a large commission, and we agree to give you a small discount on trading fees", c'mon, your fees are already above the market average for perps. You can't achieve anything if you're trying to squeeze the most out of your users and give nothing back.

Part 4. The revenue flywheel starts to spin up

So, what's actually going on here is quite interesting.

Essentially, with your commissions, you're buying into the project's tokens using something resembling DCA, but thanks to the income from Funding fees, you either offset these commissions or even profit from them when leveraging.

Over time, you accumulate a position in the token, which begins to generate a steady passive income for you. Plus, exchanges often reward their users with additional rewards through various events or partnerships. For example, Vertex has been compensating for commissions for several months now by distributing ARB, which the project received from Arbitrum, and HMX is currently distributing a drop received from Pyth Network among its users, and such events are happening continuously. Altogether, if you stick to your strategy and discipline, it's more profitable (and more fun) than just buying the project's token and staking it.

With the income from staking tokens, referral earnings, and converting various other rewards, you should start to buy LP tokens from other solid perpetual DEXs. Currently, I'm investing in MUXLP from the MUX Network project. This exchange might not fit our specific strategy, but it's great for trading, as evidenced by its constant all-time highs and records set by the exchange. This way, part of your earnings will always be in stablecoins, and you won't be tied to any specific exchange, allowing you to switch, for example, to HLP from Hyperliquid or any other DEX. It's important to research these tokens because some perpetual DEXs have too many “lucky” traders who regularly extract profits from LP, taking money away from liquidity providers. We need DEXs where traders lose. As evident from the screenshot, traders on MUX Network mostly lose against MUXLP.

Traders probably feel even worse on Hyperliquid, likely because most of them are beginners who came for the airdrop.

In the case of Hyperliquid, your deposit can only be withdrawn from HLP after 4 days, and the profit autocompounds, but I prefer to receive cash that I can withdraw immediately. Plus, the frenzy over the drop will soon end, and I anticipate a drop in trading volume on this exchange.

As a more conservative alternative, you could invest a portion of your earnings into the gUSDC Vault from GNS, but there are also nuances here.

If you have a more risk-tolerant profile, you could buy tokens of small and promising DEXs like Holdstation. Staking HOLD currently yields 42% in stablecoins, and in addition, this token is now a leader in its use with Paymaster technology on ZkSync, which adds good utility to it. But naturally, you need to study the tokenomics and various nuances of a large number of perp DEXs because you will usually have to lock up such tokens for a long time and lose sleep over their volatility.

In short, there are a plethora of options here. By the way, if you decide to buy MUXLP or HLP(HMX), I wouldn't recommend doing it through Pendle, as they provide a small but steady income in the form of MUX & esHMX, which stays in Pendle’s account and not with you.

The overall idea is to create a flywheel of revenue, where initially you're the rat spinning the wheel, but eventually, the wheel starts spinning on its own and will feed you.

Here are several useful tips:

Reduce Positions Overnight: It's crucial to reduce the sizes of open positions on exchanges before going to sleep and increase them when you have the opportunity to monitor the market and quickly respond to changes in the markets.
Resist the Temptation to Trade: As you manage your positions, you'll constantly be in the market, and there will always be a temptation to trade. You wouldn't believe how many times a day, upon looking at the market, thoughts like "This is definitely going to start rising now, I should close my short" pop into my head. Here's one piece of advice - don't do anything. Open a separate account for trading and lose money on it if you need to trade.
Avoid Chasing High Yields on Other Exchanges: Sometimes, when the funding rates on Vertex & HMX are not very attractive, there might be a temptation to switch to other exchanges where the yield is higher. It's better not to, as very high yields are usually a short-term fluctuation due to one large open position and as a result - you're not the only one who noticed this yield and ran after it. Consequently, this yield will disappear within a few hours, and you will lose more on fees.
Furthermore, HMX offers about a 10% yield in esHMX for holding an open BTC position, and Vertex often provides double-digit returns on your deposit. So, you can easily compensate for temporary poor funding rates with these returns.
Use Separate Wallet: I recommend using a separate wallet for this strategy and not visiting any sites other than perp DEXs with it.

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