This is the first of a series of articles discussing the crypto arbitrage opportunity space as well as Starscape Capital’s trading approach. Part two will discuss specific barriers in crypto and Starscape’s methods to resolve them.
The numbers have been beaten to death by now, and nearly anyone you ask will know, if nothing else, that Bitcoin has been making a lot of people a LOT of money.
But.
The ride up to the moon has not been a comfortable one, and many people have lost their nerve and sold out of their positions at a loss or chased gains in one altcoin or another. Our team is no exception — although we’re arbitrage specialists, we still maintain personal crypto portfolios and have plenty of horror stories of monumental fuckups. Take our Chief Investment Officer’s most recent move — he participated in the Icon (ICX) ICO, but sold his entire stake at .00006 BTC as soon as it began trading on Binance because he expected it to drop in early trading. It didn’t, and the current price, a few days later? Quintuple that. Of course, that .00006 BTC exit was still a 10x on the ICO price, but such is crypto that you can lose sleep over such a paltry gain.
That’s no moon.
With all the madness and pursuit of riches going on, the cryptocurrency markets encounter a ton of volatility — large and rapid changes in price. These swings happen at roughly the same time between exchanges, but due to various reasons exchange prices don’t quite move in lockstep, resulting in price gaps between different exchanges. Even when prices are fairly stable, these differences persist to a smaller degree. Here’s an example from last week featuring Bitcoin, the grandaddy of crypto:
Check out those prices — $14.3k on Bitfinex, about 1k more on GDAX, couple hundred less on Poloniex, and…is that $18k on Bithumb? Though they trade the same coin, these exchanges can have radical differences in how they function and in the consumer base that uses them, which is reflected in these price differences.
This is where arbitrage, and Starscape, come in.
Market efficiency is in danger! The ‘A’ stands for arbitrage.
A textbook definition of arbitrage has it as “the simultaneous purchase and sale of the same, or essentially similar, security in two different markets for advantageously different prices”. In standard models of efficient markets, arbitrage is one function that aligns prices across markets closer to fundamental values. Arbitrage trades are characterized by fast trades, low per-trade profit, and minimal-to-no risk. By buying a security relatively low from one place and then immediately selling it relatively high to another, an arbitrageur is able to lock in a profit that is small, but quick and low-risk.
In crypto markets, arbitrage activities are only starting to gain momentum. This immaturity combines with other market traits such as substantial fiat deposit/withdrawal times to exchanges and regulatory differences between countries in which exchanges operate, resulting in tremendous unrealized arbitrage opportunities. Additionally, there are many exchanges trading precisely identical securities (i.e. the same coin), which makes transferring coins between exchanges very straightforward compared to arbitraging traditional securities, which can often involve trading functionally rather than literally identical securities.
The simplest method of crypto arbitrage involves, as mentioned previously, buying a coin on one exchange, withdrawing it to another, and then selling there at a higher price. Astute readers may notice an obvious drawback to this approach — moving coins between exchanges can take a while to happen, and by the time your withdrawal has arrived the mispricing may have corrected itself or even reversed. That’s why it’s generally preferable to arbitrage with margin trading, which enables short selling. Short selling is the sale of borrowed securities, in this case coins that you’ve bought more cheaply elsewhere. In this scenario, the arbitrage opportunity is no longer exposed to this time risk.
In arbitrage, time can really be a monster.
All in all, profits from these arbitrage trades can really add up, to the tune of returns in the tens or even hundreds of percent per month. For the upcoming Arbitrage Flagship Fund, we’ve chosen to set our return benchmark (or baseline) at 50% per month.
You may not believe such a return is possible, and the skepticism is completely understandable! In any other asset in any other market, such a return target might be absurd. But when considering the current state of crypto markets and look at the huge volatility and accompanying pricing gaps, it’s evident that 50% is not only very achievable, but could easily be surpassed in a market spike or crash. Our team is already trading our own capital with arbitrage techniques, and the most profitable single trade so far was a 10% return in the hours following the China ICO ban announcement a few months back. That’s 10% in a single trade, with no price risk incurred. For those interested, we regularly call out notable trades and interesting opportunities on our Twitter.
Think about this— a mere 0.25% price difference between exchanges results in monthly gains of over 50% after 180 trades, or roughly 6 per day. Further, cryptocurrency markets are open 24/7 and thus more lucrative than traditional markets with limited operating hours.
These quarter percents add up.
Of course, we firmly believe that these conditions are temporary, and as money and investors continue to rapidly pour into cryptocurrency, the pricing gaps will close. That is why the Flagship Fund has a 4 month lifetime, after which we will re-evaluate the market state and raise a new Fund after revising our methods and approach. Realistically, we anticipate that this period is the highest the return target will ever be apart from an eventual market crash, which will be a passing event that cannot be accurately predicted.
We encourage all readers to try an arbitrage trade themselves — take a look at the exchanges you have access to, observe the pricing gaps, and capitalize on the fact that a trader with the ability to quickly buy from one exchange and sell to another stands to make quite a bit of money.
About Starscape Capital: We seek to exploit pricing inefficiencies through arbitrage. The upcoming Arbitrage Flagship Fund will raise capital for this purpose.
About the ICO: Opens Jan 19. Ends after 1 week or when 3,000 ETH has been raised. Tokens are used to receive profits and reclaim invested ETH. Tokenholders will also be able to contribute to future funds ahead of the public.
