Core Question

We'll be looking at what trading the ratio means as a sort of method of arbitrage from trading.

What is it?

I know Publish0x is crypto-oriented and crypto-minded, but I have to use the most famous example. That is gold and silver. Stackers (people like you and me who accumulate these precious metals) closely monitor the gold to silver ratio, which tells you how many ounces of silver you need to get one ounce of gold. The current average for this is at about 60, but that has been increasing since post 1965 after all silver left US coinage. It has gone from about 15 to 60. But that is besides the point. The point is that right now, the average is 60:1. That means that if the ratio is at or around this number, then both metals are fine to buy. However, when it drifts to say 80:1, that means that silver is historically underpriced compared to gold. So then, what people do is they will trade gold for silver, and when the ratio collapses to say 45:1, they will trade their silver for gold. Also, if they don't trade they use it as an indicator of what to buy. The higher the ratio, the better it is to buy silver and vice versa for gold.

But, how does that benefit them? Well, say you trade 10 ounces of gold when the ratio was 80:1. Without any premiums (an extra cost over the current price to cover profits and costs of labor, logistics, and machines), you would get 800 ounces of silver. Now when you exchange that back into gold at a 45:1 ratio, you get about 17.78 ounces of gold. So, by trading the ratio, you managed to earn 77.78% on your investment. That is pretty good in the world of investing in a short time span. 

How does that apply to crypto?

Well, in order to apply this to crypto, which is a bit harder due to crypto being new compared to gold and silver, we take two cryptos. Let's take BTC and ETH. Do note we can choose something else like USDC and BTC, but I'll cover that later. If we take the average ETH to BTC ratio (so how many ETH is takes to get one BTC), then we look at the current ratio and decide, should I trade my BTC for ETH (if the ratio is high by historical data) or ETH for BTC (if the ratio is low by historical data). 

Now, if we want to use stablecoins, you can. You essentially just look at the price. When it falls out of normal range, you decide whether to trade stablecoins for BTC (low price) or BTC for stablecoins (high price). This is sort of how we thought markets worked as kids, you buy low and sell high, but we know there is much more to that like time and fees and delays. 

The risk

The biggest risk is history. First of all, crypto has a very short history, so there simply isn't enough data points. Another problem is that crypto is so volatile that you might need to be trading like 2 times a day back and forth. It might or might not work, but it is very tedious, along with paying fees. 

If we look at the gold and silver ratio example, in 1965, the average was about 15. Now it is 60 and climbing higher all the time. That means that while your model might say to buy at a 75 ratio, the ratio could keep rising and you would never sell, meaning you just traded away a powerful and appreciating asset for a weaker one. 

One other risk is mood and overall sentiment. When doing the stablecoin thing, you are essentially speculating on the future price. It would be no different from buying with cash a memecoin. The crypto could be cheap compared to historical highs, but it might be getting abandoned, leaving you with a worthless token.

DISCLAIMER

I am not a financial advisor. Always do your research before trading ratios. I hold no responsibilities for any losses you may encounter. No investment is truly ever safe nor guaranteed.

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