Mainstream Crypto Derivatives Arbitrage Strategies Analysis From Blofin- Dec

Market Overview

At the beginning of December, affected by the Fed's hawkish attitude and the expectation of advanced interest rates hike, the price of the cryptos fell sharply. Since then, the bearish sentiment has increased significantly, resulting in a significant decline in funding rate arbitrage and futures arbitrage returns, while the basis arbitrage of altcoins is hardly feasible.

Fortunately, benefiting from the sharp rise in volatility, the returns of cross-exchange arbitrage strategies have increased.

Perpetual Contract Arbitrage

Affected by the market downturn, the return of perpetual contract funding rate arbitrage in December was only about 20% of November, which was 0.397% (about 4.86% annualized), and the ideal rate of return on the average daily funding fee was only 0.0128%.

Due to the low funding rate in December, it is difficult for the funding rate arbitrage strategy to operate across the board. In about 75% of the time, the funding rate can still support the operation of half positions, while in about a week after the sharp fall in December, usually only 1/3 of the positions can operate normally.

Taking the Compound USDT deposit rate as the risk-free rate, the annualized excess return in December is only 0.66%.

However, due to the high volatility seen in December, the cross-exchange basis has increased. Compared with November, the average daily basis of BTC perpetual contracts has risen to 0.056%, while that of ETH has reached 0.067%, and the basis can exceed 0.1% at some time.

In this environment, the return of the cross-exchange arbitrage strategy rose against the trend. Among them, the theoretical monthly yield of BTC contract cross-exchanges basis arbitrage increased from 1.49% to 1.72%, while the theoretical monthly yield of ETH contract cross-exchanges arbitrage increased from 1.69% to 2.09%.

With a 0.03% basis as the entry standard, whether BTC or ETH, the uninterrupted operating of strategy is still feasible. The good performance of the cross-exchange arbitrage strategy continued in 2021Q4.

Since the withdrawal of liquidity often starts from altcoins, the related arbitrage strategies are relatively affected the most.

Under the influence of bearish sentiment, starting from Dec 4, the basis of several representative altcoin perpetual contracts turned negative. At the worst time, the basis was lower than -0.1%, the average basis was -0.04%, and there was no sign of improvement. Basis does not meet the minimum operating requirement of 0.05% except on Dec 1.

Futures Arbitrage

Similar to perpetual contracts, investors' expectations have fallen significantly due to the sharp fall in the market, resulting in a significant convergence of the futures' basis. The average daily basis in December also fell to around 1.18%, of which the basis before Dec 18 was generally lower than 1%, with a minimum of 0.04%. Around Christmas, the daily basis has rebounded as the market picks up.

Compared with November, the convergence of futures basis is becoming more and more obvious. Investors are reluctant to pay a higher premium even for newly generated annual futures. Considering that the liquidity of the crypto market tends to decrease in the future, the arbitrage return of futures may still fall to some extent, but its high basic income level determines that this strategy is still the highest-yielding one.

Market Trends in the Short and Medium Term

The expected time for the Fed to raise interest rates has been brought forward to March, and the number of times will be up to four times. In addition to raising interest rates, the Fed will also accelerate the pace of collecting liquidity by shrinking its balance sheet. At the same time, the Fed also said that "capital markets should prepare for rising volatility". As a secondary risk asset, cryptos may usher in further declines due to liquidity contraction.

Due to the deepening degree of market institutionalization, the market will tend to be neutral when liquidity shrinks, and the profit range of funding rate arbitrage may further narrow. However, thanks to the sensitivity of institutions to macroeconomy, the short-term fluctuations in the crypto market brought about by macroeconomic changes may become more and more obvious, which is relatively favorable for basis arbitrage.