HashKey: Inventory of cryptocurrency arbitrage opportunities and DeFi arbitrage trends


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The overall trend of cryptocurrency arbitrage venues is from exchanges to decentralized DeFi markets, and more arbitrage mechanisms may be derived.

Written by: Lin Buren, at HashKey Capital Research
Reviewer: Zou Chuanwei, Chief Economist of Wanxiang Blockchain, PlatON

Arbitrage refers to the market, investors use the price system of the market economy is imperfect, to obtain additional profits by buying and selling behavior. Arbitrage activity can help improve the effective functioning of financial markets and asset pricing efficiency, increased market liquidity.

This paper focuses on arbitrage mechanism to encrypt money market research in order, we find that encryption currency industry as a whole at an earlier stage of development, lack of improvement in the overall market trading system and regulatory measures, and therefore there is a big arbitrage space. Currently there are a variety of market arbitrage mechanism, in theory, almost all can achieve arbitrage, but in practice arbitrage operation is likely to involve a number of risks wear, as well as arbitrage process all the formalities costs. In the future, arbitrage mechanisms will always exist and become more abundant, helping the market develop more effectively.

Reasons for arbitrage

Generally speaking, arbitrage generally appear in some markets mature and involved relatively small number of investors use the information gap arbitrage behavior to obtain additional revenue. In traditional financial markets, due to the size of the market development and improve the trading system, arbitrage margins continue to be compressed.

Arbitrage in the financial market is faster and more convenient than other markets. This makes arbitrage opportunities in the financial market always short-lived. Once the arbitrage space is discovered, investors will quickly implement arbitrage and return the market to no arbitrage. In a state of equilibrium. Therefore, how many arbitrage opportunities exist in the market and the length of time arbitrage opportunities exist can determine the effectiveness of the market’s mechanism and the degree of marketization.

Cryptocurrency arbitrage mechanism

Encryption currency industry as a whole in the earlier stages of development, the overall market is still a lack of comprehensive trading system and regulatory measures, and therefore there is a big arbitrage space.

From multiple dimensions, cryptocurrency arbitrage mechanisms are mainly divided into the following categories:

Cross-currency arbitrage

Cross-currency arbitrage is also known as triangular arbitrage refers in an exchange for arbitrage trading between the two currencies on the formation of three. For example, in an exchange, the cryptocurrency A has two trading pairs: A/BTC and A/ETH. Assuming that at a certain time, when the price of A is greater than A/ETH in the A/BTC trading market, the price of A/BTC is 11 yuan , A/ETH price is 10 yuan. The specific arbitrage steps are as follows:

  1. The initial capital investment is 100 yuan worth of ETH, and ETH is used to purchase cryptocurrency A in the A/ETH trading market at a price of 10 yuan to obtain A with a total value of 100 yuan;
  2. Sell ​​A in the A/BTC trading market for 11 yuan to obtain BTC with a total value of 110 yuan;
  3. Change 110 yuan of BTC to ETH, get a total value of 110 yuan of ETH, and a total profit of 10 yuan .

Cross-currency arbitrage under ideal conditions can be achieved without risk, but the reality due to various factors may reduce the arbitrage profit.

  1. First, cross-currency arbitrage transactions mainly involve three items, we need to consider the exchange fee. If the total arbitrage capital is relatively high, the transaction fee involved may greatly reduce the arbitrage profit.
  2. Cross-currency arbitrage requires Exchange with high liquidity. If arbitrage funds are large and liquidity is insufficient, not enough orders will cause transactions to be matched in time and miss the best arbitrage opportunity. If the market price order is adopted, the price of the arbitrage underlying asset may fluctuate greatly, reducing the overall income.
  3. Limited assets may be the subject of cross-currency arbitrage. According to the market value of cryptocurrency and the degree of recognition, the exchange will choose the number of online trading pairs. Assets with multiple trading pairs that can be used for triangular arbitrage are generally mainstream cryptocurrencies, and triangular arbitrage cannot be applied to most altcoins.

Cash arbitrage

Arbitrage refers to arbitrage between futures contracts based on the presence and spot currency exchange encrypted within the spread.

Generally speaking, the futures price represents the future trend of the spot price, and the contract price of the goods on the expiration date of the futures will definitely converge with the spot price. But before delivery time, futures prices and spot prices are likely to exist Basis (the difference between the spot price and futures price), based upon a large difference arises opportunity of arbitrage is.

Arbitrage including forward and reverse arbitrage Basis Basis arbitrage.

Forward Basis arbitrage refers to when the spot price is lower than the futures price, arbitrageurs can sell the futures contract at the same time buy the same amount of cash establish arbitrage positions. When the price gap between spot and futures prices tends to be the same (not necessarily the expiry date of the futures contract), the futures contract is closed and the corresponding spot is sold at the same time to obtain a profit. Basis reverse arbitrage is the opposite operation, when the spot price is higher than the futures price, arbitrageurs can buy the futures contract and sell the same amount of cash establish arbitrage positions. When spot and futures prices tend to be the same, close positions at the same time for profit.

Although theoretically logical point of view, the realization of arbitrage is relatively simple, but a number of risks and uncertainties actual operation.

  1. First, the basis difference between the futures price and the spot price changes all the time. Due to market price fluctuations reason, basis at some point may become large. In this way, both the futures and the spot in the hands of users will lose money, so the timing of opening a position and the subsequent judgment of the market are particularly critical in futures arbitrage.
  2. There is warehouse explosion risk arbitrage related to the futures contracts. Although the leverage of futures contracts in futures arbitrage is low, the ” pins ” of individual exchanges will still make user contracts liquidate.

Therefore, in general, the technical threshold for future arbitrage is high and requires a high level of judgment on the market trend, which is not suitable for novice users to participate.

Exchange arbitrage

Arbitrage refers to the exchange encrypted so cheap to buy the currency at a particular transaction, and sold at high prices to get where arbitrage the difference in exchange another one.

The large number of encryption currency exchange market, the price of each exchange in the same currency a slight difference at the same time will be. When the market fluctuates violently, the rise or fall of the price of cryptocurrency is often started by a certain exchange. The subsequent spreads between the various exchanges will attract arbitrageurs to move bricks, and finally smooth out the spreads in each exchange.

Exchange arbitrage will be limited by the blockchain transfer time of cryptocurrency and exchange review time. When the difference between the exchange occurs, arbitrageurs need to be cheap to buy in a short time and transfer to High Exchange were sold at a profit. But if the block chain network congestion (such as Ethernet and Bitcoin Square frequent jams occur) or the exchange will result in a longer review time can not be timely interest arbitrage damaged.

Therefore, most of the institutional investors will be quantified in each exchange reserve in advance in order to explore a large number of encryption currency arbitrage opportunities, which will skip this step transfer delay caused by malpractice, but the drawback is that you need to deposit large sums of money in exchange China and Israel are ready to arbitrage at the expense of the liquidity cost of funds.

DeFi arbitrage

DeFi arbitrage usually refers to borrowing at low interest rates in a DeFi market, and assets deposited in another DeFi market to get high interest rates. When there is a difference between the borrowing and deposit rates of the platform and the deposit rate is higher than the borrowing rate, arbitrage opportunities will appear.

And arbitrage described above except that, DeFi arbitrage is the use of the interest rate differential encryption currency products will be profitable rather than direct use of the underlying asset price difference.

Generally speaking, interest rates in the DeFi market are relatively high. The main reasons are as follows:

  1. Decentralized DeFi agreement is still in its early stages, the high volatility of currency encryption, over-collateralisation, intelligent risk factors such contracts will become DeFi agreement to provide users with high interest rates to compensate for risk. Similarly, funds deposited in the traditional financial lending market will bear lower risks, so the DeFi market needs to use high interest rates to compensate for the risk exposure brought by the decentralized mechanism.
  2. High interest rates contribute to DeFi cold start some new projects. At present, most of the funds are deposited in the mature DeFi market with liquid mining, and some new DeFi projects have not yet issued governance tokens and cannot provide liquidity incentives, resulting in poor early liquidity of the project, so high interest rates can be very good At the same time, arbitrage opportunities between DeFi markets will appear when users are attracted to attract traffic.

The following is an example of the arbitrage process: USDC’s annual interest rate for borrowing in the Compound market is 6.07%, and the annual interest rate for deposits is only 2.21% , while the USDC deposit interest rate in the Nuo Network market is as high as 11.8% . Therefore, for the same cryptocurrency, users can choose to lend USDC in the Compound market and deposit it in the Nuo Network market. If the interest rate remains the same and without considering the handling fees and other expenses, an annual interest rate of 5.73% can be obtained, and there is a large room for arbitrage.

Another high-level DeFi arbitrage method is to borrow ETH (the currency with the lowest borrowing interest rate in the market) in the Compound market, and convert it into USDC (the currency with the highest deposit interest rate in another market) through the exchange and deposit it in Nuo Network, thereby achieving a higher annualized rate of return of 9.19% .

Figure 1: Compound market interest rate information (partial)

HashKey: Inventory of cryptocurrency arbitrage opportunities and DeFi arbitrage trendsFigure 2: Nuo Network market interest rate information (partial)

Similarly, using the above logic DeFi arbitrage can be applied to any two of the lending market, including a number of loan service center of the exchange offer, as long as the loan interest rate and deposit rate there is a difference that is arbitrage.

There may also be arbitrage space between the DeFi market and the staking of some projects. Borrow and borrow through the low-interest market and convert it into staking currency on the exchange for high-interest staking to earn interest rate differentials.

In addition, DeFi market there is a more complex method of arbitrage and high threshold: the use of smart contract loopholes and lightning loan characteristics arbitrage.

Flash Loans is designed for developers to make loans instantly without providing any collateral. All operations are completed in one transaction (one block confirmation time). Developers can borrow money from the DeFi project reserve pool that supports flash loans, provided that the funds are returned to the fund pool before the end of the transaction. If this fails to timely return the funds repository, the transaction will be withdrawn in order to ensure the safety of the reserve pool.

On February 16, 2020, the DeFi project bZx suffered an ” arbitrage attack ” triggered by flash loans. Hackers used an error in the bZx smart contract to flow the bZx funds that should have been locked to Uniswap and further transferred the funds to Compound for lending , By continuously calling the instructions of the bZx margin trading function to increase the exchange rate of WBTC and ETH and ultimately profit. Of course, this type of arbitrage is not common and flash loans are limited to developers who have the ability to write code. Meanwhile arbitrageurs need to seize the contract loopholes and arbitrage, for most ordinary users lightning loans almost impossible to use arbitrage, and therefore not widely practical.

In summary, the use of high and low interest rates in both lending market arbitrage the difference is more commonly DeFi arbitrage operations. It should be noted that users may encounter the following problems in the process of DeFi arbitrage:

  1. First, DeFi market interest rates will be adjusted according to supply and demand at any time. The decrease in interest rates after users make capital deposits will reduce their income and cause them to be inconsistent with expected interest rates.
  2. Lending process is the essence of arbitrage in DeFi operation of amplifying financial leverage, risks being liquidated, although leverage is not high but still exist. In the case of drastic fluctuations in market conditions, asset losses may be caused.
  3. Smart contractual issues DeFi program. At present, there have been many hacking problems caused by smart contract vulnerabilities in the cryptocurrency market that have threatened user funds. Therefore, large amounts of funds borrowed through smart contracts require DeFi to have extremely high security.

Arbitrage through DeFi can eliminate the price difference between different DeFi platforms to a certain extent. First, arbitrage will lead to changes in interest rates reduce DeFi arbitrage space. With the emergence of arbitrage opportunities, most arbitrageurs will lend low-interest-rate currencies, leading to increased demand in the market and insufficient supply, resulting in an increase in lending rates.

On the other hand, the amount of deposit currency if high interest rates continued to increase will lead to increased supply and falling demand, resulting in lower deposit rates. The interest rate design mechanism in the DeFi agreement reflects the supply and demand factors in the DeFi market, and the emergence of arbitrageurs can narrow the interest rate differential in the DeFi market. Interest rate arbitrage mechanism will play a role of regulator DeFi market feedback to the real lending rates.

With the rise of the DeFi market, more and more lending projects will come out, and the high interest rate differential in the market will exist for a long time, which to a certain extent also reflects that the development of the DeFi market is still in its early stages.

High interest rate differential between DeFi project is mainly reflected in some of the new issue of DeFi projects and more mature works, new DeFi project will generally have a higher interest rate to attract users. However, with the maturation of the DeFi market and the continuous influx of arbitrageurs, the arbitrage space will gradually decrease. In addition to using high interest rates to attract users, new DeFi projects in the future also need a more complete and comprehensive incentive mechanism to ensure the liquidity of the project.

Cross-border arbitrage

Cross-border arbitrage refers to an arbitrage method in which arbitrageurs buy cryptocurrency at a low price in fiat currency in one country and sell it at a high price in fiat currency in another country to earn the difference.

Since different countries have different supply and demand and national policies on encryption currency, often lead to inconsistent encryption currency prices, so there is an arbitrage opportunity. For example in 2018 frenzied speculation encryption currency in South Korea leads the user to the local legal tender currency denominated encryption prices higher than many other countries, is called “kimchi premium” (Kimichi Premium).

The arbitrage mechanism and operation in cross-border arbitrage are not complicated. The main process is: buy cryptocurrency at a relatively low price in the home country, then transfer it to the fiat currency exchange of the high-premium country through the blockchain for sale, and finally through the fiat currency foreign exchange Transfer back to your home bank. Although the operation and logic of cross-border arbitrage are relatively simple, the entire process will be subject to many restrictions.

  1. Users need to open accounts in foreign exchange legal tender. Fiat currency exchanges often need to KYC users and apply for local bank savings cards. Most exchanges are restricted to domestic users due to legal compliance, so it is more difficult and costly to open an account.
  2. Foreign exchange funds are restricted. Due to foreign exchange control reasons, the amount of legal currency transferred through banks is generally limited, which is also destined to make very limited profits from arbitrage.
  3. Timing and fewer arbitrage profits. The last time there was a high premium for cryptocurrency was in South Korea at the beginning of 2018. The reason for the premium was due to the bull market in the cryptocurrency market at the end of 2017, which is relatively rare. Although there may still be irregular price premiums in various countries, cross-border arbitrage needs to consider foreign exchange and exchange fees that will reduce profits.

The role of cryptocurrency arbitrage

Arbitrage is often considered a necessary condition for the effective functioning of financial markets, arbitrage can be a reasonable market price for the underlying asset. In the digital currency market, the price of cryptocurrency often changes significantly due to regional policies, good cooperation and other related information, while arbitrageurs use the arbitrage mechanism to accurately position the price of cryptocurrency in various exchanges in the market (in DeFi arbitrage, interest rates) , To achieve the current state of balance between supply and demand.

Meanwhile, the network transparency of information within the industry as a whole play a supervisory role in the efficient operation of a trading system in investor can fully enjoy the timeliness of transactions and bring to reduce transaction costs. On the other hand, arbitrage mechanism can encrypt the whole currency market more standardized, so that each exchange can feedback the real asset prices. Arbitrage can also promote global users’ consensus on encrypted assets and accelerate the future development of the entire industry.

The development of cryptocurrency arbitrage

Although Bitcoin was born ten years ago, but the overall encryption currency trading market is still in its infancy. Due to the lack of regulatory measures in the industry and the limitation of the overall capital scale of the market, there is still room for arbitrage in the cryptocurrency market, but there are fewer and fewer people who can seize arbitrage opportunities and make profits.

From the perspective of arbitrage sites view, encryption currency arbitrage opportunities in the market first appeared in the difference between the multiple exchanges, so in the early arbitrage the difference between the general use of encryption currency exchange arbitrage and carry out cross-border exchange arbitrage, etc. . With the advent of derivatives, arbitrage has become a new type of arbitrage. Until the recent rise of the DeFi market , arbitrageurs have focused on the DeFi market, hoping to use DeFi’s unique mechanism to discover more arbitrage opportunities.

Since the DeFi market is a new type of market that is earlier than centralized exchanges, there is a large amount of arbitrage space worth exploring. So arbitrage place overall trends from the center of encryption currency exchange DeFi to decentralized market development, and could rise to more arbitrage mechanism.

From the point of view of operation arbitrage, arbitrage early encryption in the money market and the market return to a larger time feedback longer affordable, so arbitrage can be manually operated to achieve the sale of assets. Arbitrageurs need to monitor the price of the exchange in real time, and immediately perform manual pending orders and transfer operations when they find arbitrage opportunities.

However, as the size of the trading market has increased, arbitrageurs have poured in, and manual price monitoring has been unable to implement operations in a timely manner. Most arbitrage opportunities may be fleeting. Thus most of the quantization using the API interface the programmer to select a background access exchanges, to complete the operation by the exchange code program (arbitrage robot). Exploit code preset program arbitrage will save the tedious manual processing operation and to always monitor the market prices continuously find arbitrage opportunities, which will become the main arbitrage ways, such as more recent projects DeFi be used by hackers intelligent contract vulnerability arbitrage, arbitrage and to achieve all this code programs based.

to sum up

Encryption currency arbitrage mechanism with the maturity of the market has gradually started to develop and derive more structured program arbitrage, arbitrage arbitrage has become more complex and requires a certain technical threshold, for ordinary users simply move Brick arbitrage is almost unprofitable. In addition, the entire cryptocurrency market has passed the wild growth stage of exchanges, and the arbitrage space has gradually decreased.

Encryption money market at present there are a variety of arbitrage mechanism, in theory, almost all can achieve arbitrage. However, the actual arbitrage operation may involve many risks and the wear and tear of various fees in the arbitrage process, so it is not truly risk-free arbitrage. With the development of encryption and the evolution of the money market, arbitrage mechanism has gradually developed into a kind of valuable consideration in excess of the financial instruments. In the future, the arbitrage mechanism in the cryptocurrency market will always exist and become more abundant, becoming an indispensable part of the rapid development of the market.