SBF's Perspective: 2 Arbitrage Methods Make the Cryptocurrency Market a New Blue Ocean for Quantitative Funds, While DeFi Represents the New World of Finance

The high volatility of cryptocurrency assets has attracted many funds this year, with accumulated returns exceeding 140% as of last month. The innovative capabilities in the DeFi sector have also entered the radar of traditional finance. Foreign media "Forbes" interviewed SBF, the founder of FTX, whose career spans traditional finance, crypto, and DeFi. The following is a summary and translation.

The cryptocurrency market has undergone significant changes this year. On one hand, traditional financial capital, including hedge funds and quantitative funds, is beginning to enter the cryptocurrency market. On the other hand, the composability of DeFi allows services in this market to iterate quickly, including innovations such as liquidity mining, NFTs, GameFi, and other new models. The total value locked (TVL) in DeFi has reached $859 billion.

A Crazy Day Making $25 Million

FTX founder and CEO Sam Bankman-Fried mentioned in a recent interview that during the 2018 market frenzy, the price difference of Bitcoin between Japanese and American exchanges exceeded 10%, with South Korea reaching as high as 30%. Just from arbitraging the premium alone, they made $25 million in a single day at the peak of the madness.

SBF stated that at the time, the massive influx of retail investors buying in was something the exchange liquidity providers couldn't handle, causing prices to continuously rise, creating excellent arbitrage opportunities for traders in other markets, but also meaning that users couldn't get the best prices.

However, with native crypto liquidity providers and quantitative funds such as Alameda Research entering the market, liquidity has significantly improved.

"Overall, the capital that maintains liquidity in the crypto market is now in place, which reduces the slippage of crypto assets, decreases arbitrage, and leads to fairer prices and higher trading volumes."

As the crypto market becomes more liquid, even the most seasoned traders find it challenging to make more than a 10% profit from arbitrage daily, but for many quantitative fund whales, making millions of dollars a day is not a difficult task.

SBF observed that unlike before, if a large amount of capital enters a specific platform now, arbitrage traders may only see a 10 basis point (0.1%) difference between platforms, rather than the over 10% price differences seen in the past.

However, the liquidity of the crypto market still faces challenging moments. For example, during the price plunge last week, Bitcoin dropped below $40,000 on Huobi, while Coinbase fell to $42,830.

"Whenever the price of cryptocurrencies fluctuates by more than 25% in a single day, these situations can occur on some platforms. While this situation is indeed not ideal, we have moved past the times when such large price differences were frequent," SBF stated.

Current Market's Two Arbitrage Opportunities

SBF believes there are currently two types of arbitrage opportunities in the crypto market: one is quantitative strategies in trading, and the other is staking and yield.

Quantitative strategies combine various indicators such as overall economic cycles, market structure, valuations, growth, and market sentiment. As long as it fits the trading logic, arbitrage is executed, sometimes dozens of times within a second. This is also a common arbitrage method in traditional financial markets.

Compared to mature markets like bonds, stocks, and commodities, there is still a higher arbitrage space in crypto assets due to their high volatility. For quantitative funds that favor volatility, the crypto market is undoubtedly a new blue ocean market. According to Eurekahedge data, the cumulative return (YTD) of the crypto market until August has reached 145%, far exceeding other markets.

Another form of arbitrage is staking and yield.

SBF stated that for traditional investors, this is a rather peculiar type of trading.

"This type of trading is not actively arbitraging or providing liquidity as market makers. In many parts of the crypto market, you can earn a 20% annualized return by simply clicking a button. This staking and yield market now accommodates a capital volume that may reach billions of dollars."

These fixed or semi-fixed income sources stem from the demand for funds in the crypto market. The financing demand for trading cryptocurrencies far exceeds the current market's capital, leading to secondary markets willing to pay a "high interest rate of 20%" to borrow funds.

Traditionally, banks are the core institutions for financing and lending capital, but banks' entry into the crypto field has been slow, resulting in a shortage of US dollars in the crypto field.

"The shortage of US dollars in the market is reflected in the lending market. You will see lending rates of 5% to 30% in FTX's lending order book, where quantitative trading firms can earn substantial passive income by providing funds."

DeFi is the Next Financial New World, but Scalability is a Hindrance

DeFi's liquidity mining became popular last summer, significantly improving the previously inefficient use of funds. While DeFi is currently just a small corner of the crypto market, SBF believes it has unlimited potential.

"The operations behind traditional finance are quite inefficient, and sometimes even predatory. DeFi's 'huge advantage' in lending protocols is its ability to create more efficient financial models than traditional finance."

Indeed, the efficiency of traditional finance is distorted. Take the prime brokerage service offered by the main brokers, for example, which connects various market participants, including hedge funds, pension funds, insurance companies, asset managers, and liquidity providers. Users can trade directly within it, matching asset collateral and lending, such as securities, to maximize capital utilization. However, due to high costs, prime brokerage services are only open to institutional investors.

With the emergence of DeFi, the composability between various protocols, in some respects, is even better than the services provided by traditional banks.

"Traditional banks have fixed lending rates, provide services for lending out stocks, but their fees are determined internally and not through an open market. Moreover, these services are obtained through relationships, which is not a good way to create an efficient market."

Since the launch of Serum DEX last year, SBF has been continuously building a DeFi ecosystem around Serum, such as creating the liquidity providing AMM protocol Raydium, the front-end platform Bonfida, and the prime brokerage protocol Oxygen, among others.

SBF also mentioned the importance of blockchain platform scalability. He believes that blockchain's scalability and the efficiency of DeFi products are equally important because his goal is not to create a product with a two-year lifespan, which is why he chose the Solana platform.

"I am a loyal fan of Solana. Scalability is a big deal, especially considering that DeFi development is still in its early stages. What you need to consider is not creating a product with a two-year lifespan, but focusing on the next ten years," summarized SBF.