The crypto market's a hot mess, leaving many investors struggling to turn a buck. Enter the arbitrageurs.
Bitcoin and other cryptocurrencies have either been shackled to ranges or in decline since January, leaving your regular buy-and-hold investor with little option but to sell or to wait for the elusive rally.
One class of seasoned investors is faring better, though: the arbitrageurs, players such as hedge funds who thrive on exploiting price differences between different geographies and exchanges.
"In May when the market collapsed, we made money. We are up 40 basis points for the month," said Anatoly Crachilov, co-founder and CEO of Nickel Digital Asset Management in London, referring to their arbitrage strategy.
"Arb trading" involves buying an asset in a cheaper venue and simultaneously selling it elsewhere where it's quoted at a premium, in theory pocketing the difference while being neutral on the asset.
It's certainly not for everyone, and requires the kind of access to multiple markets and exchanges, and often the algorithms, that only serious players like sophisticated hedge funds can secure to make it a profitable endeavour.
Yet for investors who meet the bar, it's proving attractive.
Such "market neutral" funds have become the most common strategy among crypto hedge funds, making up nearly a third of all currently active crypto funds, according to PwC's annual global crypto hedge fund report published last week.
K2 Trading Partners said its high-frequency trading crypto arbitrage fund, which is algorithmically driven, had returned about 1% this year through to the end of May, even as bitcoin slumped 31% in the same period.
Meanwhile Stack Funds' long/short trading fund with exposure in liquid cryptocurrencies saw its single biggest monthly loss of about 30% in May, while its arbitrage-focused fund shed 0.2%.
YOUR FUNDS FROZEN
While arbitrage has long been a popular strategy in many markets, the young crypto sector lends itself to the approach as it boasts several hundred exchanges across a world with inconsistent regulation, according to participants.
Hugo Xavier, CEO of K2 Trading Partners, said arb trading benefited from a lack of interconnectivity among crypto exchanges: "That's good because you have different prices and that creates arbitrage opportunities."
For instance, bitcoin was trading at $27,493 on Coinbase on Monday, versus $28,067 on Bisq. Bitcoin is down 44% this year, and at December 2020 lows.
Yet market watchers also point to the possible pitfalls, including technical snafus on exchanges slowing or freezing-up transactions, potentially robbing arb traders of their edge. Some lightly regulated venues in smaller countries, which offer many good arb opportunities, pose extra risks.
"It's normal for an exchange go offline," Xavier added. "Your funds can be frozen for some reason."
Price discrepancies have typically arisen because of the less experienced retail traders who make up the bulk of crypto trades, particularly in the derivatives market. And, while arbitrage strategies are direction-neutral, they tend to perform better when bullish markets attract more retail participation.
"Of course, you want to have retail traders on the same exchange that you are when you're doing arbitration because you will have less smart money. When there's a bullish market, retail volume comes back," Xavier said.
"If the markets are moving sideways or going down, retail traders cool off. Opportunities are fewer because most of people there are market makers and they are efficient."
Markus Thielen, chief investment officer at Singapore-based digital asset manager IDEG said that there had been a shift in recent months, with arbitrage opportunities mostly appearing during "market stress situations".
"So the market structure has fundamentally changed on the arb side," he said, adding their arb strategy generated returns of 2% in the last eight weeks.
Yet Katryna Hanush, director of business development at London-based crypto market maker Wintermute, said arb trading ultimately had a limited shelf life because inconsistent pricing across different exchanges was bad for investors.
"As more institutional players come into the space, the arb opportunities will be eliminated."