Kwenta DEX Lures Traders to Capture Bitcoin, Ether Returns Regardless of Direction

Tokens issued by perpetual futures-focused decentralized exchange (DEX) Kwenta Protocol have outperformed the broader crypto market in the past week as traders have moved to decentralized platforms to generate relatively risk-free returns from direction-neutral strategies.

The DEX's native token (KWENTA) surged to over $670 on Wednesday, rising from under $250 in mid-February to reach a market capitalization of more than $150 million at yesterday’s peak price. Bitcoin fell 5% over the same period, according to CoinGecko.

KWENTA is used to incentivize the growth of the Kwenta decentralized autonomous organization (DAO) and has two primary functions – staking and platform governance. Trading volumes for the token have grown steadily in the past few weeks to nearly $50 million from just $3 million at the start of this year, statistics show, contributing to $880 million in lifetime volumes since the platform’s early 2021 launch.

Kwenta works in tandem with Synthetix, a popular DEX that offers crypto, equity, and forex futures to traders. On Kwenta, Synthetix stakers take the other side of every trade. Funding rates attract traders on each side, balancing the skew. DEXs rely on smart contracts instead of middlemen to process trades.

DEX traders have found a way to profit from perpetual futures funding arbitrage opportunities by utilizing the spread in funding rates between perpetual futures on different exchanges.

By taking bullish long and bearish short positions on the futures contract and the underlying asset, traders can capitalize on the difference in funding rates between the two markets.

For example, at writing time on Thursday, bitcoin (BTC) perpetual futures on Kwenta have an hourly funding rate of -0.001935%, giving a daily rate of -0.04% pocketed by short position holders. The daily yield on such a position at a 25x leverage – the highest offered by Kwenta – is close to 1%.

On dYdX, another DEX, the funding rate for bitcoin is 0.000164%, meaning it is paying 0.003% daily to traders who hold BTC perpetual futures on the platform.

The difference between funding rates can be exploited with the help of a market-neutral strategy.

A trader can place a bearish short position on Kwenta and collect the funding rate of 0.04% per day and simultaneously take a long position on dYdX and pay the funding rate of 0.003% per day. That way, the trader can safely pocket the difference in funding rates while bypassing market volatility.

“As there is a difference between the funding rates, the trader profits from the difference after all fees,” according to Synthetix documents.

Funding is similar to an interest payment. It is a set percentage of one’s position size that traders either pay, or get paid, at regular intervals. If funding is positive, longs pay shorts, and if funding is negative, shorts pay longs.

Funding rates are used to adjust the price of the contract over time to keep it in line with the price of the underlying asset.

Just as traders pay funding, those on the opposite side of the trade collect funding, based on market demand. This can boost profit and loss on directional positions, or be used as part of a more complex strategy.

However, funding reduces the profitability of a trade, and increases risk of liquidation. For example, hourly funding of 0.01% is about 87% annualized, Kwenta’s technical documents show.

Traders can utilize funding rates to create their own strategies, such as basis trading and funding rate arbitrage. These common strategies are known as Delta Neutral, where short and long exposure is balanced and returns are made regardless of market direction.