Crypto Arbitrage

Market Insights Jan 29, 2021

Unlike traditional assets, crypto markets are far less efficient. As this is a new asset class, many opportunities for arbitrage exist.

While arbitrage opportunities are appealing to crypto-arbitrageurs, they do come with risks, in particular the volatility and liquidity risks. Crypto-assets might sometimes not have enough liquidity, a market-maker should make sure daily volumes are consistent before aiming at an arbitrage.

Here are some benefits to crypto arbitrage:

  • Quick profits. If everything goes according to plan, it's a plausible way to increase your capital. At the same time, it’s all about speed so you might make money faster than with regular trades.
  • A wide range of opportunities. There are more than 200 exchanges where you can buy and sell cryptocurrencies, which means a plethora of profitable arbitrage opportunities.
  • Cryptocurrency markets are still young and volatile. Hence, most exchanges don’t share information and work on their own. Most cryptocurrencies experience many quick rises and sharp drops, which lead to price disparities and profitable arbitrage opportunities.
  • There is less competition compared with traditional markets. Not every arbitrage trader is willing to give crypto a chance, which makes crypto space less competitive.
  • Cryptocurrency price differences tend to range between 3% to 5%, and sometimes reach up to 30-50% (in extreme cases).

Three types of crypto arbitrage can be explored

  • Cross exchange arbitrages

A cross-exchange arbitrage is when a trader benefits from price differences of the same asset that trades on different markets or exchanges: a trader would typically analyse the bid-ask spread for the asset on several exchanges and detect an arbitrage opportunity when the bid price on one exchange is higher than the ask price on another exchange for the same cryptocurrency. Once the trader starts to buy and sell, the arbitrage consumes the order books until all opportunities are gone. The size of the opportunity depends on the depth of the order book on both exchanges.

  • Basis arbitrage (spot-futures)

Since the launch of bitcoin futures trading by the Chicago Board Options Exchange (CBOE) and the Chicago Mercantile Exchange (CME) at the end of 2017, futures have gained considerable traction among investors and traders. As of January 2021, 12 futures exchanges amount for over $10 billions of open interests. This growth leads to many arbitrage opportunities: when a crypto-asset price is higher on futures markets than on spot markets, an arbitrageur buys in the spot market and sells the same asset in the same quantity in the futures market, and vice versa. Since the futures price will expire at the same price as the spot price on the expiry day, the difference becomes the “risk-free” spread for the arbitrageur.

According to the head of the largest institutional crypto lending desk (Genesis), Matthew Ballensweig, who sits on the front line of passing this USDC deposit flow to institutional borrowers:

"capturing basis, by borrowing cash or USDC to buy BTC in the spot market and short the near-dated future or perpetual product on any derivative exchange [to] capture the premium or funding rate is ONE example that is yielding 15%+ annual right now with no market risk. In other words, the forces driving the magnitude and cadence of these arb opportunities is greater than the cash supply available to marker-makers and prop shops to squash these arb opportunities."

  • Crypto index arbitrage

Index arbitrage is a trading strategy that attempts to profit from price differences between the crypto index and its underlying assets. This can be done in any number of ways depending on where the price discrepancy originates. It may be an arbitrage between the same index traded on two different exchanges, or an arbitrage between the instruments/products that track the index, and the components of the index themselves.

Why trading an instrument against its constituents?

During their life, Crypto index instruments such as CTI’s (Crypto Traded Indices) will often trade at a premium or at a discount to their NAV, depending on the market forces driving the index and its constituents. In such scenarios, liquidity providers can capture these differences by issuing CTIs (if CTI price > aggregated value of its constituents) against the delivery of the constituents or redeeming the CTIs (if CTI price < aggregated value of its constituents) against its constituents - these actions help ensuring there is a convergence between the CTI prices and their net asset values (NAV).

In the case of Trakx’s Crypto Traded indices (CTIs), liquidity providers who aim at issuing new CTIs will first transfer the constituents to the CTI’s vault’s wallet address. Then, smart contracts and/or a centralised entity will issue more CTIs to the participating liquidity providers’ wallet addresses. Once received, the liquidity provider will sell those newly issued CTIs. Conversely, liquidity providers who aim at redeeming CTIs, will first buy the CTIs, then redeem them against their constituents.

These mechanisms are typically in place to ensure a good liquidity and efficient markets on all the CTIs listed on an exchange.

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Carole Laizet

Senior marketing manager with 15+ years of experience in the Financial Industry (traditional Banking as well as Crypto Assets). Responsible for market research @trakx.io