In the ever-changing cryptocurrency market, quantitative arbitrage strategies have gradually become a wealth code favored by investors for their stability and risk control. In this webinar, Pacific Waterdrop invited two partners of Hashflow Asset Management, Allen and Leon, and hosted by Xiaozhou, Executive Director of Pacific Insurance Asset Management Hong Kong, to discuss the core logic of this strategy and its market potential.
Guest Introduction
Allen: Born in traditional finance, he has been deeply involved in stocks, futures and other fields. In 2018, he entered the cryptocurrency market and took the lead in introducing the quantitative model of the traditional market into crypto trading. He has more than six years of experience in digital asset quantitative trading. The crypto asset quantitative team he led successfully hedged in the two crises of March 12, 2020 and FTX in 2022.
Leon: He has many years of experience in hedge funds and risk management. He has worked for Citibank and top domestic private equity firms. In 2018, he began to focus on quantitative arbitrage strategies in the cryptocurrency market.
host:
Xiaozhou: Currently serving as Executive Director of CPIC Asset Management Hong Kong, he has been focusing on fixed income investment for a long time.
Wonderful Q&A content
Opening: The birth and background of quantitative arbitrage strategies
Xiaozhou:
Allen and Leon, you both started out as senior practitioners in the traditional financial field. What opportunity led you to enter the cryptocurrency market and choose quantitative arbitrage as your main direction?
Allen:
“Quantitative trading is already very mature in traditional finance, but as we entered the cryptocurrency market in 2018, we found that the volatility, proportion of retail investors, and overall immaturity of this market are very suitable for the application of quantitative strategies. The unique mechanisms of the cryptocurrency market, such as perpetual contracts and funding rates, have also brought us new arbitrage opportunities.”
Leon:
“At that time, we saw that many trading mechanisms in the crypto market were similar to those in the traditional market, but due to low liquidity and lack of professionalism among market participants, there was huge room for quantitative arbitrage. In addition, our team had deep experience in programmatic trading, so we quickly discovered the opportunity.”
Question 1: Please give a detailed introduction to the operating logic and profit sources of quantitative arbitrage?
Allen:
“The essence of quantitative arbitrage is to use the price difference between spot and perpetual contracts to make a profit. We buy spot and short perpetual contracts at the same time. Since long positions in perpetual contracts need to pay funding rates, this fee eventually becomes a source of income for arbitrageurs.”
Leon:
“The core advantage of this strategy is that by hedging spot and contracts, we can achieve market neutrality. Whether the market is rising or falling, the portfolio will not be affected by price fluctuations.”
Summary points:
Funding rate: Settled every 8 hours, the annualized return can reach 20%-30% in a bull market, and can still maintain 8%-10% in a bear market.
Risk neutrality: Hedging of spot and contract ensures stable returns and avoids market fluctuations.
Question 2: The market is volatile and operations are complex. How can quantitative arbitrage ensure long-term stability?
Allen:
“We use a unified margin account to integrate the fund management of spot and contract transactions to avoid the fund risk of cross-account operations. At the same time, we provide basic protection through the deep liquidity of blue-chip coins (such as BTC and ETH).”
Leon:
“In addition, our dynamic rotation mechanism is another key point. We monitor the funding rates of all major currencies every day and adjust the portfolio based on returns and risks to ensure that returns are maximized and risks are minimized.”
Summary points:
Unified margin account : simplify fund flow and reduce settlement risk.
Dynamic rotation: adjust the configuration in real time to optimize returns and risks.
Question 3: If the market spread suddenly widens or the funding rate becomes negative, how do you deal with these potential risks?
Allen:
“When the price gap widens, we will reduce or re-allocate our positions in a timely manner based on the retracement data monitored in real time. In addition, the deep liquidity of blue-chip coins ensures that the price gap can return quickly.”
Leon:
“As for negative funding rates, we have set up a strict stop-loss mechanism. If a currency has a negative funding rate for five consecutive days, we will remove it from the portfolio.”
Summary points:
Risk response: reduce positions, adjust positions or reduce leverage.
Stop-loss mechanism: If the negative funding rate exceeds 5 days, the strategy will be adjusted.
Question 4: For some investors, directly holding BTC may be more attractive. So why choose quantitative arbitrage?
Leon:
“The returns from holding coins directly depend entirely on market price fluctuations, which is very risky. Quantitative arbitrage provides a low-risk, stable return option. For risk-averse investors, this balance is even more important.”
Allen:
“For portfolio management, we also recommend combining coin holding with quantitative arbitrage to achieve enhanced returns. Coin holding captures rising opportunities, and arbitrage strategies avoid volatility risks.”
Summary points:
Low-risk stability: suitable for risk-averse investors.
·Combination advantage: Combining coin holding and arbitrage to increase returns.
Question 5: How long can the bull market in the crypto market last? How long can the high-yield stage of arbitrage strategies last?
Allen:
“Based on historical cycles, the cryptocurrency market has a halving cycle approximately every four years. We expect that the high-yield phase of the bull market may continue for the next six months until the market enters the early stages of a bear market.”
Leon:
“Even in a bear market, quantitative arbitrage is still a preferred strategy. Through refined management and multi-currency allocation, we can continue to maintain low drawdowns and stable returns.”
Summary points:
Bull market phase: The high-yield period is expected to last for 6 months.
Bear market advantage: The strategy has a small drawdown and can still provide stable returns.
Question 6: Many viewers are interested in the specific operations of quantitative arbitrage. For example, if you have 1 million US dollars, what is the actual operation process?
Allen:
“We use spot and perpetual contracts for arbitrage. For example, $1 million can be used to buy $2 million of spot and short an equivalent perpetual contract. This involves moderate leverage, which is generally controlled within two times. This operation ensures that the income comes from the funding rate, not market fluctuations.”
Leon:
“In addition, today’s exchanges support unified margin accounts, which greatly simplifies the operation process. In the past, we needed to constantly adjust positions between spot accounts and contract accounts, but now all operations can be completed in the same account, which not only reduces the risk of fund transfer, but also improves efficiency.”
Summary points:
Leverage control: Appropriate leverage can amplify returns while reducing risks.
Unified account: Simplify the operation process and reduce the risk of capital flow.
Q7: Quantitative arbitrage seems to have a low drawdown, but there are still risks. Can you elaborate on the potential risks and how to manage them?
Allen:
“The main risks include:
1. Price spread fluctuations: The price spread when opening a position may widen in the short term, resulting in floating losses.
2. Negative Funding Rates: Although funding rates are mostly positive in the long run, they may turn negative in the short term.
To deal with these risks, we set strict stop-loss rules. If a currency has a negative funding rate for 5 consecutive days, we will remove it from the portfolio. In addition, through multi-currency configuration, we reduce the impact of fluctuations in a single currency. "
Leon:
“The repair of the retracement also mainly depends on two points:
1. Price spread regression: Market price spreads will eventually return to normal ranges.
2. Funding rate recovery: long-term positive returns will gradually make up for short-term negative returns. "
Summary points:
Spread volatility and negative funding rates: These are the main sources of risk, but they can be effectively controlled through multi-currency configuration and strict stop loss.
Drawdown repair mechanism: realized by price difference regression and funding fee recovery.
Question 8: In extreme market conditions, such as sudden and large price fluctuations, how should quantitative arbitrage respond?
Leon:
“We have taken a variety of measures:
1. Diversify your positions: The allocation ratio of a single currency will not exceed 5%.
2. Dynamic position adjustment: When the price difference widens, positions will be reduced to reduce risks. If it is judged that the price difference has reached its limit, positions will be increased to capture profits. "
Allen:
“The team’s technology and processes are also crucial. For example, during the 312 incident (March 12, 2020), many exchanges crashed, but our system was able to issue an alarm immediately and quickly increase positions after the system was restored, ultimately making a profit.”
Summary points:
Diversified allocation: reduce the risk of a single currency.
Technical support: respond to extreme events through alarm and rapid response systems.
Question 9: How does quantitative arbitrage perform differently in bull and bear markets? Is there a big difference in yield?
Allen:
“In a bull market, funding rates are high and arbitrage returns are usually between 20% and 30% annualized. In a bear market, funding rates are lower and annualized returns are about 8% to 10%. Even if the market enters a bear market, arbitrage strategies can still provide stable returns because risks and volatility have been hedged.”
Leon:
“In a bear market, we will pay more attention to the rotation of funding rates and ensure maximum returns by selecting the best currencies. For example, in the past bear market, we optimized the currency configuration and controlled the overall drawdown within 0.6%.”
Summary points:
Bull market returns: up to 30%.
Bear market return: about 8%-10%, very low risk.
Question 10: I understand that quantitative arbitrage strategies are a bit like cash management enhancement tools in traditional finance. Is it more appropriate to switch from traditional bonds or money market funds to this strategy rather than directly participating in high-risk assets? "
Allen:
"Your understanding is very accurate! The characteristics of quantitative arbitrage strategy are stability and low risk. It is more like an upgraded version of cash management tools. Compared with bonds or money market funds, our annualized returns are higher, while the risks are kept at an extremely low level."
Leon:
“That’s true. Quantitative arbitrage is an ideal choice for the stable part of asset allocation. Especially for institutional investors or high net worth clients, traditional cash management tools have low returns in the current interest rate environment, and our strategy can achieve significant enhancement effects.”
Summary points:
·Upgraded cash management tools: higher returns and extremely low risks.
·Asset allocation advice: Suitable for investors who are switching from bonds or money market funds.
Question 11: If the spot price continues to rise, and we short the perpetual contract, will our profits be affected due to the excessively high funding rate?
Allen:
“This is a good question. In a unified account, the profit and loss of spot and perpetual contracts are calculated together. Even if the funding rate rises, our income still mainly comes from the spread fluctuations and the positive income of the funding rate. In addition, our system will automatically adjust the margin to ensure the stability of the overall position and avoid unilateral risks.”
Leon:
“The advantage of a unified account structure is that it allows for unified management of spot and contract assets, reduces the hassle of capital flow and margin replenishment, and ensures the stability of the overall strategy.”
Summary points:
Unified account: Comprehensively calculate profits and losses to ensure overall benefits.
Funding rate risk is controllable: income mainly comes from price difference and positive rate.
Question 12: In extreme market environments, such as the March 12 incident in 2020, how should quantitative arbitrage respond?
Leon:
"In extreme events like the March 12 incident, we will reduce our positions immediately to ensure risk control. At the same time, our technical system will quickly issue an alarm to help us adjust our strategy. In addition, we focus on blue-chip currencies with high trading depth and good liquidity, such as BTC and ETH, to avoid losses due to insufficient liquidity of small currencies."
Allen:
"This extreme volatility can also be an opportunity for us. For example, after the market recovered, we quickly added positions to capture the spread and achieved excess returns after the March 12 incident." Extreme market volatility is both a challenge and an opportunity for us.
Summary points:
·Risk control: Reduce positions in a timely manner and focus on blue-chip currencies.
Technical support: alarm system and rapid adjustment mechanism.
The above is the full content of this seminar. We invite you to continue to pay attention to the Pacific Drop webinar.
