The end of the year is usually a time to relax and prepare for the holidays, but the last few weeks of 2021 show no signs of a break in the cryptocurrency market.

One of the headlines related to Terra reached an all-time high in terms of total value locked (TVL), with the project surpassing Binance Smart Chain (BSC) to become the second-largest decentralized finance blockchain after Ethereum.After hitting the $20 billion TVL mark on December 24, according to Delphi Camel, but this is by no means forming or forming a bearish signal.

Currently, there are only 14 protocols on the Terra chain, compared to 257 protocols on BSC and 377 protocols on the Ethereum network. Terra’s protocol has been very successful in attracting liquidity, and the recent launch of the Astroport protocol has coincided with a rapid rebound in Terra’s native governance token, Luna, reached a new all-time high on December 26, 2021.

Looking at USD TVL versus LUNA, the former has experienced exponential growth since September 2021, while the latter has remained fairly flat over the same period. It is not difficult to see that the contributing factor to the recent rise in USD TVL is the rise in the price of LUNA itself.

While an increase in the price of governance tokens generally indicates investor confidence in the chain and protocol, it also appears to generate more lucrative arbitrage opportunities.

Let’s take a closer look at some strategies used to arbitrage between LUNA and its bonded asset, bLUNA.

Why is there a spread in Terra’s market?

LUNA is the governance and staking token of the Terra blockchain, while bLUNA is the token that represents staked LUNA and its corresponding block reward. Since bLUNA is fungible and transferable like LUNA, it is also traded on Terra’s decentralized exchange.

Like other currency or token pairs traded on exchanges, LUNA/bLUNA pairs are traded on different decentralized exchanges (DEXs) such as TerraSwap, circular market or spaceport There may be different prices due to price inefficiencies across different platforms. Arbitrageurs will profit from buying at a lower price in one protocol and selling at a higher price in another, helping the platform address price inefficiencies and ultimately achieve a fair price across all exchanges.

In addition to the common causes of price inefficiency, there are other factors that are particularly relevant to the nature of bLUNA that cause LUNA/bLUNA prices to vary by agreement.

• The price of bLUNA is higher than that of LUNA Anchor Protocol. This is because bLUNA bound and minted on Anchor can only be burned and redeemed back into LUNA after 21 days (plus three days of processing time) unless it is burned instantly.

• Since bLUNA represents not only the value of staked LUNA, but also the block reward staked during the 21-day lock-up period, its value is always higher than LUNA. As you can see in the graph below, most of the time, bLUNA’s price per LUNA on Anchor is just below 1, and three different outliers show that bLUNA happens to be more valuable, at 0.97 bLUNA per LUNA.

• Most of the time, LUNA is priced higher than bLUNA on the DEX, probably due to:

(1) More users are selling bLUNA than buying on DEX (so bLUNA is less valuable) because it would take 21 days to burn bLUNA on Anchor Protocol if not instant burn. Therefore, if users want to get back LUNA instantly, they need to go to DEX to sell bLUNA. (For instant bLUNA burning on Anchor, the rate is the same as TerraSwap.)

(2) Users generally do not need bAssets like bLUNA unless they need to use them as collateral on Anchor. Currently, Anchor offers a bonding function that exchanges LUNAs for bLUNAs at a ratio that is very close to but slightly below 1 – i.e., investors get slightly less than 1 bLUNA for 1 LUNA. Although the exchange rate on DEX is better (traders get more than 1 bLUNA with 1 LUNA on DEX), users tend to seek the most convenient way, which is to use Anchor Bond to get their bLUNA, so that they do not have different switch between protocols.

How to Take Advantage of Terra’s Arbitrage Opportunities

According to the price difference explained above, there are two main ways to arbitrage LUNA and bLUNA.

TerraSwap, Loop Markets and Astroport all offer swaps for LUNA/bLUNA. There are often small price differences between these DEXs, which creates an arbitrage opportunity for traders to buy the currency pair at a lower price on one DEX and sell it at a higher price on another DEX.

The chart below shows the observed daily average price of LUNA/bLUNA from swaps on different platforms during December 2021. The ratio is the amount of bLUNA actually received (after fees and slippage) divided by the amount of LUNA offered to the swap. As described in the previous section, one LUNA can exchange multiple bLUNAs on the DEX due to the increased demand for LUNAs on the DEX.

The chart below calculates the daily arbitrage returns between any two of the three DEXs by year. The best opportunity comes between TerraSwap and Loop on December 15, with an annual yield (APY) approaching 600%.

Arbitrage between DEX and Anchor

Investors can exchange LUNA for bLUNA on the DEX that offers the highest bLUNA per LUNA, burn bLUNA on Anchor, and wait 21 days (plus 3 days) for more LUNA. Note that burns on Anchor must be normal “slow” burns; instant burn will not work as the exchange rate is the same as TerraSwap.

The graph below shows the APY for arbitrage between different DEXs and Anchors based on 24-day (21 + 3-day processing after Anchor burn) annualized returns.

Lido’s Also added 8% APY from LUNA Liquid Collateral as a risk-free benchmark return comparison. In December, the highest APY hit 80% on December 27, and has since fallen sharply below the new year’s risk-free return.

This may be because Terra’s growing popularity and greater participation in different Terra protocols helps rationalize prices across platforms, reducing price inefficiencies and arbitrage opportunities, thereby creating fairer prices.

Savvy investors are always on the lookout for the next opportunity

LUNA/bLUNA arbitrage opportunities exist across different protocols on Terra, as shown by historically observed swap data in December 2021. Traders can choose a riskier way to arbitrage between different DEX platforms like TerraSwap, Astroport, and Loop Markets, or a safer way to arbitrage between these DEX platforms and Anchor because they are willing to hold bLUNA for 24 days .

The annualized returns of DEX and Anchor arbitrage strategies consistently outperformed the risk-free Lido liquid staking in December 2021, until recently when returns nearly evaporated on January 1, 2022.

This may be due to more participation and price rationalization in the Terra protocol. Arbitrage opportunities may arise again in the future due to fluctuations in trading volume and participation or the launch of new DEX protocols.

The views and opinions expressed herein are those of the author and do not necessarily reflect the views of Cointelegraph.com. Every investment and trading move involves risk and you should do your own research when making a decision.