Covered Interest Arbitrage

Covered interest arbitrage is a strategy used to profit from interest rate differentials between two currencies while eliminating exchange rate risk. An investor borrows in a currency with a lower interest rate, converts it to a higher-interest currency, and simultaneously enters a forward contract to sell the currency back at a future date.

This ensures the investor knows exactly how much they will receive at the end of the term. In the crypto domain, this often involves bridging assets across different blockchain protocols to capture yield differences.

The process relies on the efficiency of forward markets to hedge against price volatility. By covering the position, the investor avoids exposure to spot rate fluctuations, focusing purely on the interest rate spread.

It is a core mechanism that keeps global financial markets and decentralized liquidity pools in equilibrium.