Arbitrage in Crypto: Profit from Price Differences

Arbitrage is a procedure for quickly buying and selling the same asset on different markets to take advantage of price differences between markets.

What is arbitrage?

By their nature, markets, such as stock and cryptocurrency exchanges, are inefficient due to many factors: different degrees of access to information by market participants, different trading tools and methods, transaction costs, human error, and much more. Due to these inefficient factors, prices for the same asset – for example, a cryptocurrency – often differ from market to market.

Arbitrage traders exploit these price differences by almost simultaneously buying an asset in a market where it is cheaper and then selling it in a market where it is more expensive. As a rule, the main reason for the existence of arbitrage is the inefficiency of the market. Arbitrage practitioners capitalize on this by making markets more efficient, ensuring the same price for the same asset on different exchanges.

By buying on a cheaper exchange and selling on a more expensive one, arbitrageurs narrow the "spread" available between those exchanges, thereby reducing the opportunity for arbitrage and, therefore, making markets more efficient. The arbitrage system is a critical strength because it ensures that no asset deviates from its fair value over long periods of time and enhances the flow of liquidity between exchanges.

Given the nature of the way arbitrage is conducted (buying and selling the same quantity on different exchanges), the arbitrator takes virtually no price risk on this strategy. Nevertheless, arbitrage does involve risk, which arises from the need for almost instant execution of the strategy and the cost of trading (commissions). Fans of arbitrage usually end up paying a lot of commissions, since each unit of trade requires the trader to pay for the various exchanges on which he/she trades.

Arbitrage trades can be between two or more markets with one or more assets. These can be, for example, simple transactions such as buying bitcoin (BTC) at $14,975 per coin on exchange A and selling it for $14,987 on exchange B. There can also be more complex transactions such as triangular arbitrage, which involves buying and selling three different assets on three different markets.

With advances in technology, such as automated trading, opportunities for arbitrage trading tend to be eliminated much faster, making the practice more challenging for traders. Nevertheless, as long as the markets remain imperfectly efficient, arbitrage will continue to serve its vital function.