Mainstream Crypto Derivatives Arbitrage Strategies Analysis From Blofin - Jan

Market Overview

Compared with December, the poor performance of the crypto market continued in January 2022. Affected by the expected liquidity contraction policies of central banks in main capital markets, the overall market value of the crypto market shrank to about $2 trillion. Market activity decreased significantly under the combined influence of the sharp decline in volatility and the dominance of bearish market sentiment. The profit of funding rate arbitrage and basis arbitrage, which are more sensitive to volatility, further declined. However, the cross-exchange arbitrage strategy benefits and stands out from other strategies.

Perpetual Contract Arbitrage

The market downturn has prompted a further convergence of the perpetual contract basis. Compared with December 2021, the ideal return of perpetual contract arbitrage in January 2022 was only 0.237% (3.34% annualized), which shrank by nearly 31% again.

The further decline in the funding rate level caused by bearish sentiment is why perpetual contract arbitrage is becoming more and more complicated: the average daily total funding rate in January was only 0.022%, down about 0.006% from December. In this case, the funding rate arbitrage strategy can only operate in half positions for 12 days, while the remaining time can only open one-third of the positions.

Taking the Compound USDT deposit interest rate as the risk-free annual interest rate, the annualized excess return of the funding rate arbitrage strategy in January was about 1.03%, slightly better than in December. However, both absolute and relative returns were still low.

For non-mainstream cryptos, the basis arbitrage is not available. In January, the average contract basis of non-mainstream cryptos was -0.049%, and only briefly higher than 0 on January 5, but still does not meet the opening requirements. With bearish sentiment continuing to dominate the market, the basis arbitrage strategy has temporarily lost its universality, and only some specific underlying can still fit the strategy.

However, in the sluggish market, the arbitrage strategy is outstanding due to the impact of liquidity and the widening cross-exchange basis. The ideal monthly return of BTC's cross-exchange basis reached 2.25% (30.57% annualized), and the monthly return of ETH's cross-exchange basis reached 3% (42.63% annualized).

Compared to last month, BTC's cross-exchange spread earnings rose by about 30%, while ETH's cross-exchange spread earnings rose by 43.71%.

If the price difference ≥ 0.03% is regarded as the opening standard, cross-exchange price difference arbitrage can maintain the uninterrupted opening. From 2021 Q4 to the present, cross-exchange spread arbitrage has ideally provided continuous and stable returns for at least three months.

Futures Arbitrage

Compared with December, the basis of the futures further converged in January. After January 20, the average daily basis of the futures fell below 1% and further fell below 0.5% at the end of the month. Under tightening expectations, investors are unwilling to pay more premiums for far-month contracts. At the same time, there has been a long-term negative premium in front-month contracts, which further limits the income of futures basis arbitrage and have performed worse than the cross-exchange price difference arbitrage strategy.

Market Trends in the Short and Medium Term

With the advent of the global economic tightening cycle, both the Federal Reserve and the European Central Bank have embarked on the path of monetary policy normalization. Under such circumstances, further shrinkage of liquidity is inevitable. This means that although the crypto market may rebound in the short term, the decline will become the theme in 2022, and the bear market will last for at least one year.

However, risk aversion will usually become dominant when the market tends to bear, which is relatively beneficial to derivatives trading, and basis arbitrage strategy and options strategy may benefit from it. In addition, as market sentiment gradually stabilizes and bullish sentiment slowly rises, it will push progressively the funding rate strategy income back to the average level in the next 1-2 quarters.