Mainstream Crypto Derivatives Arbitrage Strategies Analysis From Blofin - Feb

Market Overview

Under the liquidity tightening cycle of the encrypted asset market, the returns of arbitrage strategies have generally been significantly negatively affected. Although the implied volatility of the market continues to rise due to factors such as interest rate hike expectations and war, and the number of large market fluctuations has increased, it is relatively beneficial for option strategies; but for arbitrage strategies, as bearish sentiment still dominates the encrypted asset market in February, the returns of other arbitrage strategies are further limited except for cross-exchange spread strategies.

Perpetual Contract Arbitrage

Due to the continuous decline in the crypto market in February, the performance of the funding rate arbitrage strategy related to strong bullish sentiment continued to decline in February 2022. The strategy's expected return was only 0.16% (annualized about 1.95%), and the average daily total funding rate was roughly 0.018%. At the level of the funding rate in February, the time for the strategy to operate in half positions was reduced to 2 days, and only one-third of the positions could run most of the time, even no position could operate sometimes.

Considering handling fees and friction costs, the funding fees strategy seems to be unprofitable in February. With the Compound USDC deposit rate as the risk-free annual interest rate, the performance of the funding rate arbitrage strategy in February was the same as the risk-free interest rate. If the return on the strategy cannot be significantly higher than the risk-free return, holding assets rather than open positions may be a better choice.

Basis arbitrage strategies for altcoins are also tricky to implement. In February, the negative basis of altcoins contracts tracked by Blofin ran through the whole month. The average basis fell to -0.05%, which means that investors are hard to obtain arbitrage opportunities and can only wait for the market to improve before reactivating the strategy.

Cross-exchange spread arbitrage strategy is one of the few "lucky ones" in the perpetual contract arbitrage strategy. Benefiting from the insufficient liquidity level of the crypto market and the market volatility in the second half of February, although the average cross-exchange spread income decreased by about 12.7% compared to January, the expected return of BTC cross-exchange spread arbitrage strategy is still 1.95% (26.07%), while ETH cross-exchange spread arbitrage expected return is 2.64% (annualized 36.74%).

In addition, if the spread ≥ 0.03% is taken as the opening standard, arbitrage across the spread can still maintain uninterrupted opening and continue to provide continuous and stable returns in the bear market cycle.

Futures Arbitrage

Under the bear market cycle, futures traders have lowered their expectations of the market, which are directly reflected in the basis, causing the futures' average basis to further converge to a new low of about 0.155% compared with January. In addition, at the end of the month, the futures' basis even showed a negative basis phenomenon on certain specific dates, and the overall basis level remained below 0.1%, making it difficult for the strategy to obtain significant gains under the current market environment.

Market Trends in the Short and Medium Term

As a result of the Russia-Ukraine war and a series of sanctions against Russia, the crypto market has ushered in a wave of safe-haven liquidity, which has temporarily controlled the further decline in crypto assets. In addition, the Federal Reserve is caught in a dilemma between controlling inflation and economic recession. Since investors have priced in the possibility of the Federal Reserve raising interest rates seven times this year, the impact of the Federal Reserve's policies on risky asset markets, including the crypto market, maybe weakens without additional new policies.

As the arbitrage space continues to converge in a bear market cycle, spread arbitrage strategy and options strategy will still play an essential role in maintaining overall returns. In addition, after a series of important events in March (FOMC meeting, central bank interest rate decisions, option delivery), market sentiment has stabilized and rebounded. Arbitrage strategy returns are expected to improve for some time to come, but they are still some way from returning to the level during the bull market.