The universe of crypto arbitrage in SA

David Farelo from CURRENCY HUB explains why his company is unique relative to its competitors.

CIARAN RYAN: Crypto arbitrage has become a huge business in South Africa. Companies like CURRENCY HUB were set up to help South Africans buy cryptos like Bitcoin at a discount on overseas exchanges, and sell them in South Africa at a profit. That’s exactly what arbitrage is – buying cheap in one market and selling it at a higher price in another.

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% in the last few years. That’s still attractive enough to make it worthwhile for thousands of people to do every day. Last week it was announced that market leader in this space, OVEX, had decided to exit crypto arbitrage, the reason being that it accounts for just about 6% of its total business.

Well, CURRENCY HUB’s phones have been ringing off the hook since that announcement as people want to know if the crypto market is dying. Is it because Bitcoin has been dropping, is regulation around the corner, and will it squash the crypto arbitrage market out of existence?

Joining us to discuss what is happening in the world of crypto arbitrage is David Farelo, head of operations at CURRENCY HUB. Welcome David. Let’s start by unpacking some of these questions. Is crypto arbitrage, the market, dying or will it be around for a while? What’s your take on that?

DAVID FARELO: Ciaran, the simple answer to that is no, it’s not dying – it’s most certainly here and it’s alive. We can actually go back to December/November where we saw the premium around 1% to 1.5%, and that was the lowest we saw it all year. I know a lot of our competitors were not trading at that level, but because of our operations and having everything in-house we continued to trade; we lowered our fees as a result, and basically did the arbitrage for free and gave our clients back 1% net on average for the month.

Going into January, with the new supply of crypto-arbitrage trades coming into the market with the new calendar year, I was expecting that to go lower. But as a result, it almost doubled. And now we say we sat at about 2.5% on average for January.

CIARAN RYAN: CURRENCY HUB is one of several crypto-arbitrage players in the market, but you’ve got something fairly unique about that. I want you to explain what that is.

DAVID FARELO: Sure. I can unpack the reasons why CURRENCY HUB is unique relative to our competitors.

The first reason would be that our one entity is an FSP [financial services provider] and houses a number of FSP licences that allow us to manage part of the arbitrage service that fits within the traditional financial services sector – such as the booking of forex for our clients.

Number two, it’s the forex intermediary licence, which allows us to facilitate our clients’ FX outward payments to the offshore beneficiary bank to purchase the cryptocurrency offshore. Having this licence brings a number of positives to our service, one being that it increases the gross premium as you no longer need to use a third-party forex broker and pay them for that service. Our FX desk is dedicated to the arbitrage service, and thus we ensure that we have the fastest client onboarding and the quickest settlement times, with very little operational risk as a result.

Third, the client only has to speak to CURRENCY HUB, not multiple service providers throughout the supply chain. We are also, like you mentioned earlier, able to trade up to three times a day. Now this is unique in the market and it allows us to basically lock in arbitrage trades when we see a spike in the premium momentarily throughout the day. That’s huge for us and our clients.

And then, last but not least, we hedge the forex exposure; that’s also a very important part of the service, and that means that the move in the rand/dollar or rand/euro does not affect the client’s return. This makes us a pure crypto-arbitrage service provider.

We are able to trade up to three times a day. Now this is unique in the market and it allows us to basically lock in arbitrage trades when we see a spike in the premium momentarily throughout the day.

CIARAN RYAN: All right. So just to be clear on this one point, you’re hedging the forex risks. That means that whatever happens – as you mentioned earlier, the rand strengthening in December – that would not affect you when you’re doing a crypto arbitrage because there can be eight hours or 10 hours involved, and of course the currencies can move dramatically during that period of time. So, you’ve hedged that forex risk out.

There were periods last year when the Bitcoin arbitrage gap moved to about eight, even 10 [%], maybe higher. Maybe you can refresh my memory on that one, but does that mean that you would be able to jump on an opportunity like that when you see the spike, when all of a sudden, you’ve got a 10% opportunity to make a profit, and you can grab that three times in a single day?

DAVID FARELO: That’s correct. That actually happened over the weekend. Remember, [over] the weekend the forex market is closed so you can’t trade traditional forex, and therefore you can’t lock in the forex on weekends. But if that happens during the week, we most certainly can.

CIARAN RYAN: All right. Now you talk about these allocations that people have, which kicked in from January. Just explain what that is. It’s called the ‘single discretionary allowance’ and the ‘foreign investment allowance’. Explain that.

DAVID FARELO: Sure. There’s the single discretionary allowance – the R1 million allowance that you’re allowed to take out of the country per calendar year without tax clearance. And then the FIA, or foreign investment allowance, in which you are able to take up to R10 million per calendar year; but you will require tax clearance from Sars.

CIARAN RYAN: Okay, so you’ve got a total of R11 million per year that you can actually do crypto arbitrage with. What you were saying is that in December we saw the crypto arbitrage gap or the arb reduced to about 1.5%, 1.6% gross – that’s before any costs come off.

It did widen up a little bit in January, so maybe just explain: is that because [of] the allocations that people have on the single discretionary allowance, the R1 million per year that expires every December 31 and you get a new allocation come January 1. So, people have more time and they’re not trying to race to use up their allocation. Is that correct?

DAVID FARELO: That’s 100% correct. I agree with that view. Also, you’ve got to remember the tax year. The tax year comes to an end at the end of February. I know that a lot of clients do wait for March 1 to begin their trading again, so that they’re not hit with a large income-tax bill as a result of doing the arb twice in one financial tax year. But yeah, that’s my assumption.

CIARAN RYAN: I did see, having had a look at it in the last few days, that the crypto arbitrage gap had widened to about 2.6% gross, and it has been at 3%. So there definitely is some profit in that. Is that your experience – that the gap has widened?

DAVID FARELO: Yes. Coming into January, the first couple of days it was depressed, but then it opened up to about 2.5% on average, and we’ve seen it hovering there for most of January. I think the market dynamics have changed slightly. You’ve got algos [algorithms] and traders who use bots and algos that have, that have kind of [become] a bit smarter and more receptive to foreign currency – rand/dollar moves and any Bitcoin, Ethereum; any cryptocurrency move. It’s very receptive. So, these market makers have kind of become smarter and, as a result, that premium level moves with any move in those assets. So, it’s very hard to get a very big increase in the premium as a result of the more mature market, the smarter market.

CIARAN RYAN: I know that some of your competitors are saying that you can make R300 000 per year in crypto arbitrage. That is if you arbitrage your full allocation of R11 million rand per year. I know you have a problem with this claim – that profit of R300 000. What are realistic expectations for people getting into this market?

DAVID FARELO: I think it’s important to understand that cryptocurrencies aren’t regulated yet. So you can say one thing and there’s no regulator to kind of put you in your place. I think it’s a bit overstated. We like to under-promise, over-deliver. That has always been my case.

So, in terms of competitors of ours who are claiming that they can make R300 000 a year, these are the guys who are probably not hedged, and it’s highly unlikely that you’re going to get R300 000. The guys that were not hedged were basically making losses, and therefore you can’t call yourself an arbitrage provider if you’re posting losses, because arbitrage is supposed to be risk-free. So, if you’re unhedged in this market, especially with a low premium environment, you can post losses.

CIARAN RYAN: Okay. I remember back in the day – and we spoke about this before in 2017 when the arbitrage gap was as high as 20%, even 30% on occasion – you could mint money in those conditions. Explain [this] to those who don’t know why there is this arbitrage opportunity and why we are seeing the profitability of crypto arbitrage decline from about 4% to 5%, as it was in previous years, down to about 1% to 3%.

DAVID FARELO: The main reason for the arbitrage opportunities in South Africa is our exchange control laws. Basically, that enables what we spoke about earlier: the single discretionary allowance and the foreign investment allowance caps individuals at R11 million per calendar year that you can take offshore. Therefore, there’s a supply/demand constraint in terms of liquidity in South Africa for crypto. You can only access up to that amount offshore, and then you’re capped; you can no longer get any more offshore.

Added to that, the Reserve Bank is not allowing corporates and companies to purchase cryptocurrencies offshore, and that is where most of the money sits. So, if they were allowed to do that, the premium would go to zero on day one in my view.

CIARAN RYAN: In my intro I mentioned that OVEX has just announced that it’s exiting this market, the crypto-arbitrage market. Now that doesn’t mean it’s exiting crypto; it’s just the arbitrage side of it. Many people may read this as a pre-emptive move, because the arbitrage profit gap, or what’s the arb, is declining and may eventually go to zero, or perhaps that regulation may be just around the corner. What’s your reading of this? Why is it doing this?

DAVID FARELO: We’ve been dealing with OVEX for a couple of years now on many parts of our business. I think they’ve done such an amazing job in terms of educating clients and bringing [to people] the education of our crypto arbitrage and making it mainstream – put it that way. But in terms of their move to switch off their automated arbitrage service, it’s not due to the fact that [the arb is] going to zero; it’s more about allocating their resources, their core model, and they’ve basically announced to the market that they want to focus on being a global OTC [over the counter] desk and prime broker.

So, I think it’s just a smart move in terms of reallocating resources because, even though arbitrage on a high level looks very simple, underneath it there are a lot of resources that must go into it. So, it’s resource intensive. They’re just reallocating those resources to their primary, core business.

CIARAN RYAN: There are risks involved in crypto arbitrage. I just want to make sure that we understand each other here. Maybe you can just walk us through the key risks and how you go about mitigating those.

DAVID FARELO: Sure. I know we touched on a few, but let me just unpack it now.

The first one, probably the biggest one for us, is counterparty risk. We deal with authorised dealers who are essentially the banks that we are integrated with to send the forex that we purchased for our clients offshore. So that’s counterparty risk, currently hybrid counterparty risk, and then any exchange, be it electronic or OTC, where we sell and buy crypto currently from; that [is] counterparty risk too.

Then the second one would be price risk. Now we deal with mostly stablecoins. Basically, we used to use Bitcoin or Ethereum, when you would be exposed to Bitcoin and Ethereum price risk. We don’t do that anymore. It’s mostly stablecoins and therefore we mitigate the price risk on that.

Another risk is the forex risk. That’s your rand/dollar exchange rate or rand/euro exchange rate, depending on what forex you purchase. That’s a risk, but we mitigate that by providing the client with a hedge solution.

CIARAN RYAN: Okay. So, you’re basically arbitrating stablecoins and a stablecoin is a form of a crypto which is backed by a hard asset, like the rand or the US dollar. So, this crypto arbitrage exists even in stablecoins, right?

DAVID FARELO: That’s correct. It exists across all cryptocurrencies in South Africa [which] are priced at a premium. So no matter what you’re trading on, there’s a premium there.

CIARAN RYAN: David, a final question. How do people find CURRENCY HUB?

DAVID FARELO: You can go to our website, www.currencyhub.co.za. We’ve got videos on there explaining to people how the arb works, and lots of content on there to read. You can register for the arbitrage service on our website.

CIARAN RYAN: Thank you very much, David Farelo. That was David Farelo from CURRENCY HUB.

Brought to you by CURRENCY HUB.

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