Sign upWhat is carry trading and how does it work?
2025-07-11
With how fast the crypto world spins, strategies that were once exclusive to traditional finance are now making trotting their way over into the digital asset realm.
One such strategy is carry trading—a concept well-known in forex and now is increasingly popular in crypto markets.
But what exactly is carry trading, and how does it work in the context of cryptocurrencies? Well, we're about to get to the bottom of that here at Toobit Academy! Let's dive in today's trading topic.
What is carry trading?
To keep it simple, carry trading is a trading strategy. It's where an investor borrows a low-yielding asset to fund the purchase of a higher-yielding one, earning a profit from the difference—referred to as the “carry.” Now, the goal of this strategy is to exploit yield differentials between markets or instruments with different risk-return profiles.
How this would work in traditional finance is that it often involves borrowing in a low-interest-rate currency (like the Japanese yen, for example) and investing in a higher-yielding currency (like the Australian dollar, or even any emerging market bonds). Traders who do this profit from the interest rate spread, but only as long as currency values remain stable.
In crypto, the basic principle is the same, but naturally; the instruments differ.
Instead of government bonds and fiat currencies, crypto carry trades involve digital assets, lending protocols, futures markets, and decentralized finance (DeFi) platforms. These markets are highly fragmented and volatile, which creates more opportunities—but also more risk!
How does carry trading work in crypto?
In crypto carry trading, it typically exploits the difference in interest rates, lending yields, or futures funding rates between two platforms or asset classes.
How does that work? Well, here's how it could possibly play out:
Spot vs. Futures carry trade
This is one of the most common and accessible carry trade strategies in crypto. It involves capitalizing on the price difference between a crypto asset’s spot price (the current market price) and its futures price (the expected future price on a specific date).
How it works:
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Buy the asset on the spot market (e.g., 1 BTC)
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Short the same asset on the futures market (e.g., 1 BTC futures contract)
As the futures contract approaches expiration, the futures price tends to converge with the spot price. If the futures were trading at a premium, the trader locks in that spread as profit.
Example:
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Spot BTC: $30,000
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Three-month futures BTC: $31,000
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Action: Buy 1 BTC at $30,000 and short 1 BTC futures at $31,000
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At expiry (if convergence occurs): Sell BTC for $31,000 and settle the short position
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Profit: $1,000 (minus fees and funding costs)
This strategy is popular during bullish or sideways markets, where futures often trade at a premium due to positive sentiment and leverage demand.
Lending and borrowing arbitrage
Another form of carry trade leverages the yield disparities in crypto lending markets. The idea is to borrow a low-yielding stablecoin or token and lend or stake another with higher returns, often across different platforms or DeFi protocols.
How it works:
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Borrow USDC at 2% APR on a CeFi platform like Aave or Nexo
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Lend that USDC on another protocol offering 6% APR
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Earn the 4% net spread—assuming rates remain stable and funds remain secure
This approach is especially attractive in times of high DeFi activity, where yield farming and liquidity incentives push APYs upward.
Why do crypto carry trades exist?
Crypto markets are inherently more volatile and inefficient than traditional financial markets. This gives rise to frequent and exploitable opportunities for carry trading.
Key factors enabling carry trades:
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Volatility: Digital assets like Bitcoin and Ethereum can swing 3–5% daily, creating premiums in futures pricing and lending rates.
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Fragmentation: Dozens of exchanges, DeFi protocols, and CeFi platforms offer different yields and pricing for the same assets.
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Regulatory arbitrage: Restrictions in certain countries create dislocations in funding costs and capital flows.
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Retail behavior: Emotion-driven trading by retail investors often leads to mispricing, particularly in derivatives markets.
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Leverage imbalances: When futures markets are over-leveraged, funding rates can spike, creating ideal conditions for short carry trades.
These inefficiencies mean that unlike in traditional finance—where carry trade margins can be razor thin—crypto carry trades can yield annualized returns of 10% or more, especially in bull markets or during periods of high demand for leverage.
Risks of crypto carry trading
While potentially being a great trading strategy, carry trading in crypto comes with its own set of problems. It carries unique risks that traders must understand and manage before jumping the gun.
Here are some potential risks when it comes to crypto carry trading:
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Market volatility
Even the best trading strategy cannot protect you from market volatility. In fact, "hedged" trades can still suffer losses if price movements trigger liquidations or require additional collateral.
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Interest rate risk
Lending rates and borrowing costs on both CeFi and DeFi platforms are highly dynamic and can change daily.
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Counterparty risks
Centralized platforms are vulnerable to freezes, hacks, or insolvency (as regrettably seen with the FTX collapse and Celsius fallout).
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Smart contract risks
DeFi protocols that rely on smart contracts that can be exploited or suffer from bugs. Asides that, the insurance options are also limited, which shoeboxes traders in.
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Execution risks
Manual trading or delayed price entry can lead to slippage and missed opportunities. That being said, there are always advanced tools that can help, such as Toobit's BBO feature (Best Bid Offer) can help traders place precise limit orders in volatile conditions, which in turn reduces execution risk.
Final thoughts
A neat hidden strategy to carry around in your trading pocket, crypto carry trading adds a layer of sophistication to investing by offering a non-directional, yield-driven strategy. By exploiting inefficiencies across markets, traders can earn steady profits without relying solely on price appreciation.
However, with any successful trading strategy requires the following: solid market knowledge, access to reliable platforms, proper risk management and timely execution tools. Carry trading is no exception.
While the concept is straightforward, execution in the crypto world requires diligence, risk management, and up-to-date market awareness. As the crypto space matures, carry trades may become more competitive—but for now, it looks like opportunities still are plenty abound for those willing to do the work. So what will it be for you this time, Toobiters?
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