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Dharma Markets Report #6: Trading Strategies in #DeFi

Trading is integral to any well functioning capital market. By taking advantage of supply and demand mispricings, traders help the market with price discovery, and in the act of trading, also serve to bring liquidity to a market. Traders that excel at providing these services are rewarded handsomely.

Crypto markets are no different. In fact, crypto markets need traders more than ever to help bring liquidity and price discovery to an immature and inefficient market. For their crucial role in helping bootstrap a global market, crypto traders have generated massive returns. An argument can even be made that crypto markets to date have been much more lucrative to, and psychologically easier on, traders than they have been to long term investors. While the latter requires relentless patience in the face of massive volatility, traders are able to take advantage of irregular price movements without bearing as much risk.

Just as traders were needed to bootstrap traditional crypto markets, they’re needed more than ever within the decentralized financial system being built on Ethereum. Not only are these markets nascent, but the actual infrastructure that underpins them is still in development. Given such high levels of inefficiency, #DeFi is a breeding ground for traders who are willing to take on risk in exchange for massive returns.

To take advantage of the new opportunities available in the decentralized finance ecosystem, a number of new trading strategies have emerged.

Token Pair Trading

Summarized well in this article, pair trading is a market neutral strategy in which traders take advantage of mis-pricing between two highly correlated assets. So let’s say that two assets usually have a price ratio of 2:1. If the price ratio moves substantially, say to 2.2:1, then a token pair trader would short the outperforming asset and long the underperforming asset. The expectation will be that the ratio will revert back to 2:1, and the trader wil...

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