When is a Big Mac no longer a Big Mac?
The answer is when a fork happens on the Big Mac blockchain.
Probably a number of Mickey D franchisees (Miners) realised their consumers wanted pineapple slices on their Big Macs.
Why associate Big Macs with blockchain? To reference the Economist’s Big Mac Index and the concept that a Big Mac is not worth the same price in different countries. That seems to be the case for cryptocurrencies too and leads to something hedge fund managers dream about; arbitrage.
You might have heard of the ‘Kimchi Premium’ – where cryptocurrencies were trading at a hefty premium in South Korea to other jurisdictions. I personally tested the spread a few times by trading with my Korean friends (it was then I understood my destiny of being popular with Koreans) and the highest net ROI we achieved was 44.82% in January 2018 within an hour. Could you have made serious money trading the Kimchi Premium? Possibly. If you had a legitimate method of remitting money within the strict capital controls in Korea.
Were there other premiums you could trade too? Yes, there were significantly smaller premiums compared to Korea but if you were a fan of the Oracle of Omaha, you understood that even a few percentage points per trade done frequently enough could net you hedge fund beating returns.
I ran a homemade version of this trade for a bit other than my Kimchi special. I was able to buy cryptocurrencies cheaper on one exchange and sell them more dearly on another, netting decent ROIs of approximately 1%-3% each trade and also hard lessons that came with putting capital at risk vs theoretical models. At times, I made money on trades only to lose it remitting the fiat from one jurisdiction to another which led me to optimise fiat transfer costs. The fastest and cheapest withdrawal method on my selling exchange was through Visa debit cards. I received a shiny new black Visa debit card for a brand new multi currency account and was ready to plunge headlong to be a crypto mover and shaker.
That was until the exchanges ran into banking support issues, the bank pulled card support for crypto-related transactions and basically, counterparty risk made the trades’ risk-return profile untenable. Essentially, I was unable to run the trade again and my crypto kingpin ambitions came to an unfortunate premature loud, screeching halt… I wonder if my cries of frustration were heard echoing in the mountains of ‘Crypto Valley’. If you’re even remotely considering trading or investing in cryptocurrencies, please always keep Mt.Gox at the back of your mind.
However, I never stopped looking for the trade – once you’re bitten, you’ve caught the bug. After all, I needed to put my newly acquired Python skills to productive use. Staring at the order books on multiple exchanges for some time to the detriment of my perfect eyesight, I realised the persistent premiums had eroded over time.
Yet, my investment thesis on cryptocurrency arbitrage seemed sound enough and I was yet to be proven wrong. The cryptocurrency market is not a single market but a collection of siloed markets with varying degrees of liquidity. The pace of price discovery in liquid markets is assumed to be higher than illiquid markets. Hence if you were to trade a more liquid exchange against a less liquid one, you should be able to discover arbitrage opportunities or specifically statistical arbitrage opportunities e.g. mean reversion. Some of these illiquid markets are in developing markets where the opportunities are buying in a US$ denominated market and selling in a local currency denominated market. The constraint with illiquid exchanges was ‘strategy capacity’ or the inability to deploy significant amounts of capital.
Suddenly, arbitrage wasn’t looking like the arbitrage of old. Jurisdictions still retained their capital controls or introduced stricter cryptocurrency regulations, banking support for cryptocurrency exchanges progressively worsened; which should have led to widened spreads but the previously persistent premiums had significantly eroded.
Moral of the story: I had to get creative if I wanted to make my mark in cryptocurrencies.
That sparked an intellectual crusade in me; could I replicate Kenneth Griffin’s start in convertible bond arbitrage and build the Citadel of Crypto? That phrase, “Citadel of Crypto” sounds just about cool enough to try.