Convergence Failure

Convergence failure occurs when the price gap between a derivative and its underlying spot asset fails to close as expected, potentially leading to losses for basis traders. This can happen if the funding rate mechanism is overwhelmed by extreme market conditions or if the arbitrage activity is insufficient to move the prices.

For example, if there is a massive demand for long positions, the funding rate might stay high for an extended period, preventing the perpetual price from converging to the spot price. Convergence failure can also be caused by exchange-specific issues, such as withdrawal freezes or technical outages.

This is a tail risk that traders must consider when building their models. It underscores the importance of not relying solely on the funding mechanism to guarantee convergence.

Diversifying across multiple exchanges and monitoring market health is essential.