The Risk and Return of Cryptocurrency Carry Trade

Abstract

This paper analyzes the risk and return dynamics associated with cryptocurrency carry trade. A cross-sectional carry trade strategy, involving the purchase of highinterest cryptocurrencies and shorting of low-interest cryptocurrencies, yields an annualized return of 43.4% with a Sharpe ratio of 0.74. Our results show that the carry returns cannot be explained by prevailing cryptocurrency factors, including market, size, momentum, volatility, liquidity, downside risk, and platform collapse risks. Additionally, our analysis does not find any substantial connection between these returns and the fiat currency carry trade. Instead, our findings suggest that a significant portion of cryptocurrency carry trade returns can be attributed to a premium for equity market volatility risk. This study highlights the inter-asset class linkages between equity risk factors and cryptocurrency returns.

Keywords: Cryptocurrency, Stablecoin, Carry trade, Equity market volatility

JEL Classification: F31, G11, G12, G14