Actively managed crypto strategy that can do 3 arbitrage trades per day

Clients don’t know when it’s the optimal time to buy forex because they won’t know what the premium is to lock in the forex at the optimal rate.

CIARAN RYAN: Crypto arbitrage has gone mainstream in South Africa. It involves buying cryptos like Bitcoin at a discount on overseas exchanges and selling them in South Africa at a profit. How much can you make, and how quickly? Well, it used to be the case that you could make 4% to 5% on a trade, but that profit margin has dropped to between 1% and 3% – still attractive enough to make it worthwhile for thousands of people every day.

Joining us to discuss what’s happening in the world of crypto arbitrage is David Farelo, head of operations and trading at Currency Hub. Welcome, David. Perhaps just explain to those who don’t know why there is this arbitrage opportunity, and why we aren’t seeing the profitability of crypto arbitrage decline from 4-5% to 1-3%.

DAVID FARELO: Good morning, Ciaran. Cool. Thanks very much for having me on this morning. Great, I can answer that question. So the arbitrage opportunity in Africa exists due to our exchange-control laws that were passed in 1962, if I’m not mistaken. They basically allow each South African individual to send out R1 million as part of their single discretionary allowance, and then a further R10 million as part of the foreign investment allowance, which requires tax clearance certificates from Sars.

That basically puts a cap on the market in South Africa in terms of the Bitcoin cryptocurrency market pool in South Africa, and kind of puts a constraint on the demand and supply. As such, we see a crypto being priced at a premium relative to the rest of the world.

CIARAN RYAN: For those already in crypto arbitrage, is there a danger that the arbitrage or the ‘arb’, as it’s known, will disappear altogether?

DAVID FARELO: I wouldn’t say it’s a danger, but it is a possibility that this will go to somewhere close to zero. But arbitrage exists in traditional markets every single day. The only thing is that it’s being taken advantage of by big balance sheets and usually the bank, with high-frequency bots that are making small margins on big numbers every single day. So basically the premium in South Africa will start to decrease as we have seen over the past four-and-a-half years since I’ve been tracking it; but as for it disappearing altogether, I doubt it.

CIARAN RYAN: I think it should probably be pointed out that the arbitrage gap does disappear for times momentarily, and then it reappears. And it really just depends on supply and demand. There are now quite a few companies that are offering crypto arbitrage, but you at Currency Hub have done something quite different and quite unique. Maybe just tell us how you got started in all of this.

DAVID FARELO: Yes we have. So four-and-a-half years ago I decided to resign from a hedge fund in Johannesburg after working there as an analyst and a portfolio manager for about six years, and the timing couldn’t have been more perfect. I went on a career path and, before doing that, I was travelling in Southeast Asia for about three months.

That’s when I discovered Bitcoin, listening to an Andrea Antonopoulos podcast on a flight to Chiang Mai in Thailand. I got off the plane and started to buy my first Bitcoin, believing in the narrative. As such, I had basically lost R1 000 on the first trade because I bought it in South Africa at the premium, and I converted it back to dollars – and I couldn’t understand why.

That was in December 2016, and that basically took me down the rabbit hole on how I figured the premium and uncovered all the intricacies to be able to do the arbitrage as an South African individual – which led me to launching Currency Hub and doing this for South African individuals.

CIARAN RYAN: So the mistake you made there was to buy it in South Africa, which is more expensive, and to sell it overseas where it’s cheaper. You should have done the reverse, right?

DAVID FARELO: The reverse, exactly. You’ve got to pay your school fees.

CIARAN RYAN: Right. Okay. So that was the best R4- or R5 000 loss you ever made. Does it help to have deep experience in asset management and equities trading and financial markets generally, because you do come from that background – from portfolio management, right?

DAVID FARELO: That’s correct. I definitely believe so. Having the passion and experience in financial markets and having studied economics and finance, doing my CFA Level 1, Level 2, and working in London and in South Africa in the hedge-fund space on both the operational side and the analytical side, and then also managing a portfolio and trading gives me a unique sort of skill set to marry into the crypto universe, which basically leverages off a lot of the fundamentals and technicals as traditional markets.

It’s been a four-and-a-half journey to unpack the legalities, together with creating operational efficiencies and getting the necessary licences because a lot of this opportunity falls within current laws, which we can unpack later, given those licences to be able to facilitate this in a legal way and also act on the best arbitrage service to ensure that we’re given the biggest premium in South Africa by getting our transactional costs down to zero – which is what we’ve done by getting those licences and the FX intermediary licence in-house, so that we can do the fastest trade at the highest value, getting the biggest premium essentially.

CIARAN RYAN: Let’s come to that licence in a minute. But I want to just focus in on this thing that you have, which is fairly unique, and that’s a proprietary algorithm. This helps you identify the best time to trade. Explain this and why it’s simple.

DAVID FARELO: There’s quite a lot to it but let me try and simplify it.

We’ve got algorithms or APIs that are plugging into various exchanges, both offshore and local,

both on an exchange, like your Lunos and VALR and Bitstamps and Krakens, but also off-exchange OTC [over-the-counter] liquidity pools.

So we’ve bought large liquidity pools that we can tap into, in other words to buy and sell, buying offshore, selling locally, so that at any given point in time we can see what the premium is on each of those different liquidity pools. We have the choice on where to trade at any given point in time. That gives us access to a much larger market, it gives us access to the best pricing, gives us access to negotiation as well. Essentially that’s where our prop algo [algorithm], call it dashboard, that we built kind of flags to us where the biggest premium is on the day.

CIARAN RYAN: All right. So what you’re trying to do here is you’re trying to squeeze that extra few percentage, or fractions of a percentage point, out for the benefit of the client. Of course that adds up and it compounds into something quite meaningful, given that each individual has only a limited amount of money that they can trade for crypto arbitrage. We’ll get into that in a minute. But one of the big advantages that you’ve got is you’ve got a Cat [Category] 2 FSCA licence, that’s a Financial Sector Conduct Authority licence, and you are an in-house forex intermediary. That gives you a pretty big advantage over others operating in the space. Just explain how that works.

DAVID FARELO: Yes, that’s correct. These are the two sort of ‘holy grail’ licences that we use to facilitate the arbitrage. I don’t think there’s – to my knowledge – anyone else in SA that has both of these in-house. Remember, the arbitrage of crypto in South Africa is to date unregulated. Regulation is around the corner, but right now it’s not regulated.

So a lot of companies that are competitors in the space are doing this in the grey area without the need of licences, but there are certain parts of a trade that still fall within our traditional laws, such as the Fais [Financial Advisory and Intermediary Services] Act.

So when dealing forex for clients, that falls under the Fais Act, the Cat 2 licence allows us to trade or purchase forex on behalf of our clients at our discretion

Clients don’t know when it’s the optimal time to buy forex because they won’t know what the premium is to lock in the forex at the optimal rate. They will need to make that decision, but they don’t have the tools or the information to be able to do that, and obviously it’s administration intense. So the client would need to then phone the desk, the dealing room, book a trade, to do the forex side of it. So the Cat 2 licence is basically there for us to have discretion on when to buy the forex for our clients and send that offshore.

Now the FX intermediary licence basically means that we are able to facilitate that forex payment in-house.

So from an operational point of view it’s massive because we’re getting all the efficiencies in-house, but also from a cost perspective because the biggest cost in this arbitrage service is actually the forex intermediary fee that you’re paying away to a third party. Now we’re doing that in-house and therefore the premium increases as a result of that saving.

CIARAN RYAN: Are you able to hedge your client’s trades by locking in a forex rate and a crypto rate so that the profit is pretty much secured from the moment that you pull the trigger?

DAVID FARELO: Correct, yes. That is also one of the unique features of our service – that we know at the point of time when we trade exactly what the clients are going to make. It’s actually a forward market. We are able to sell the crypto on our OTC markets before they’ve even received our cryptocurrencies for our clients. So our OTC markets are taking the settlement risk, and they are taking the forex risk. That’s being removed totally.

So we’re able to lock in the forex on the buyer side for our clients and sell the future cryptocurrency which is going to reach the beneficiary bank later that evening, and therefore we’re able to know exactly at that point in time what our clients are going to make. That’s why we’ve today done over 5 000 individual trades with zero losses.

CIARAN RYAN: What’s pretty important for people to understand is that when you actually give the authorisation for the trade you know that you’re going to make a profit – there’s no risk of loss. So you’ve effectively eliminated the forex risk and the crypto risk. I want to find out from you: do you fully automate trading on behalf of the client or does the client have to give you authorisation before the trade is enacted?

DAVID FARELO: It’s definitely pretty automated and I’ll expand on that a bit more, but the clients’ are hands-off. As soon as they’ve deposited their trading capital into their Mercantile Bank account or Investec Bank account that we open in the client’s name, using our FX intermediary licence, the clients are hands-off, all they’re doing is just watching the arbitrage and profits with a live statement that we share with them on a day-to-day basis. So we are mandated, using our FSCA Cat 2 licence to be able to purchase forex when we see fit, and then facilitate the arbitrage trade for our clients when the premium is at our desired level, essentially. It’s fully handled for the client and that’s made possible by having the necessary licences.

CIARAN RYAN: So there’s a huge advantage in having your own forex broker in-house, which you have. You can lock in up to three trades a day. Now, for people who don’t understand what that means, let me explain.

Let’s say the crypto arbitrage gap widens to 5% or even 10%. In other words, the difference between the South African price of Bitcoin and the overseas price of Bitcoin is between 5% and sometimes even 10%, due to some anomaly in the market. You can then grab that profit and lock it in three times. Am I correct in that?

DAVID FARELO: Correct. This is actually another advantage. The arbitrage is already a great investment, so to say, but this just puts the cherry on top for us. Let’s use today as an example. The premium actually opened up to about 3.5%, and it’s been around 3.8% over the weekends. That’s above its short-term mean over the past three months; actually, it’s been at the highest that we’ve seen.

So what happened is we can actually lock in three trades at that premium for our clients, using our FX intermediary licence and our OTC desk, and I know that tomorrow there’ll be an influx of other arbitrages that have been waiting for a bit more premium or an increase in the premium. So there’s an influx of supply, because it’s going to be quite a number of guys ‘arbing’ tonight and tomorrow, which is going to put pressure on the local markets and push that premium back down to its short-term mean.

So we can take advantage of a high premium and generate even more alpha by locking in three trades for our clients.

CIARAN RYAN: Just quickly explain alpha.

DAVID FARELO: Sure. Alpha is an outperformance of a certain benchmark. So, the benchmark here is the cryptocurrency premium and what other competitors are getting at that time.

CIARAN RYAN: David, how do people find Currency Hub?

DAVID FARELO: You can go to our website, www.currencyhub.co.za, and there’s a registration for the arbitrage service there. Alternatively, we are also open for business on the forex side of things. So anyone doing their personal arbitrage, crypto arbitrage or any other forex-related matters – like emigration and their discretionary allowance, FIAs [foreign investment allowances] or other investments – can also on board with us to facilitate their forex needs at competitive rates.

CIARAN RYAN: Okay, so that’s www.currencyhub.co.za.

DAVID FARELO: That’s correct.

CIARAN RYAN: David Farelo, thanks so much for joining us.

DAVID FARELO: Great. Thanks very much for having us, Ciaran.

Brought to you by Currency Hub.

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