Mainstream Crypto Derivatives Arbitrage Strategies Analysis From Blofin - Apr&May

Market Overview

The Fed’s May rate hike and LUNA’s collapse brought a massive shock to the crypto market, triggering the most significant fluctuation in the crypto market since May 2021. After the LUNA incident, the overall market capitalization of the crypto market has shrunk to around $1.2-1.3 trillion, and the liquidity of the crypto market has also been significantly negatively affected. Although the rise in volatility has brought the perpetual contract cross-exchange arbitrage strategy the best return in 2022 year-to-date, the returns of other strategies have retreated significantly compared to 2022q1.

Perpetual Contract Arbitrage

During the low volatility period in April, the overall sentiment of the crypto market remained stable. Therefore, although the profit of the funding rate arbitrage strategy slightly decreased to 0.27% (annualized 3.24%) in April, it was basically the same as that in March. Considering that investors in the crypto market gradually factored in the impact of the Fed’s May rate hike in April, the diminishing returns from funding rate arbitrage did not exceed expectations.

However, the collapse of LUNA caused the confidence of crypto-asset investors to drop to a freezing point, and bearish sentiment further dominated the market, resulting in a significant decline in funding rate arbitrage returns. Compared with April, the return of the funding rate arbitrage strategy in May decreased to 0.17% (about 2.1% annualized).

If the Aave USDT deposit rate is regarded as the risk-free interest rate, the funding rate arbitrage can still obtain an excess return of 0.3%. Still, it is significantly lower than the rate of return of traditional risk-free assets such as the US 10-year treasury bond, which implies the funding rate arbitrage strategy is relatively "unprofitable".

Under the combined influence of investors' previous expectation management and the downward trend of the crypto market itself, the funding rate arbitrage strategy in April and May can usually only run with one-third of the position. Considering that the liquidity contraction in the capital market continues, the future performance of the funding rate arbitrage strategy will continue to be limited.

Due to the continuous negative basis, the related arbitrage strategies are difficult to operate for perpetual contracts based on altcoins. In April, the average negative basis of perpetual contracts for some crypto assets with relatively good liquidity reached -0.04%, and in May, it further dropped to -0.068%.

However, benefiting from the higher level of volatility, the return of the cross-exchange spread arbitrage strategy is still relatively outstanding.

In the low volatility situation in April, the cross-exchange spread arbitrage gains converged to some extent. Among them, the monthly yield of BTC cross-exchange spread arbitrage dropped to 2.09%, while the ETH cross-exchange spread arbitrage yield fell to 2.53%.

The impact of the LUNA incident in May caused the return of the cross-exchange spread arbitrage to rise sharply. The monthly return of BTC’s cross-exchange spread increased to 3.36%, while the monthly return of ETH’s cross-exchange spread rose to 4.22%. The strategy performance has been the best since the beginning of the year and significantly outperformed other strategies.

After considering handling fees and friction costs, if the spread ≥ 0.03% is the standard for opening positions, the cross-exchange spread arbitrage strategy can maintain operation in April and May. It is worth mentioning that from November 2021 to the present, the cross-exchange spread arbitrage strategy has been running stably for more than six months.

Futures Arbitrage

After the crypto market rally in March, investors’ expectations in April did not change significantly from March. However, as investors continued to lower their expectations for the crypto market, the average daily basis of futures converged to a low level of 0.11% in May. In this case, the theoretical return of the futures arbitrage has been significantly lower than that of the cross-exchange spread arbitrage and other strategies.

It is worth noting that in the futures market, the far-month premium level of mainstream crypto-asset futures contracts has fallen to around 3% at the end of May, while the quarterly futures premium level expiring on September 30 fell to around 1%, further limiting the upper bound of the performance of the futures arbitrage strategy.

Market Trends in the Short and Medium Term

Since the Fed's rate hike path has not changed significantly, the downtrend in the crypto market is unlikely to be reversed until September. In September, the Fed will conduct a periodic assessment of tightening policy. If inflation is well controlled, the crypto market may have a liquidity return at the end of the year. If inflation is difficult to control, the Fed's tightening policy may continue and make crypto-asset performance low.

It is worth noting that after experiencing the liquidity loss caused by the LUNA incident, the investor expectations and liquidity levels in the crypto market are close to the bottom. Therefore, except for the cross-exchange spread strategy, the performances of the derivatives basis arbitrage strategies are unlikely to behave well in the short term. But on the other hand, due to the lack of liquidity, the likelihood of significant fluctuation in the crypto market has increased, favoring volatility-based strategies.