What Is Arbitrage?
Admin
Aug 7, 2021
If you’ve familiarized yourself with the crypto industry, it is very likely that you have come across the term “arbitrage”. And if you haven’t, you most certainly will.
What is Arbitrage Trading?
The Oxford dictionary defines “arbitrage” as the simultaneous buying and selling of an asset in different markets in order to take advantage of price differentials.
Let’s break down exactly what that means:
Every international market is different, as a result of its complex economic climate. For instance, oil could be cheap in the USA because it is abundant, but expensive in Hong Kong as it is difficult to transport and store it.
The asset is exactly the same in both the USA and Hong Kong. Their varying market conditions, however, mean that Hong Kong has a much higher price for oil. This provides an “arbitrage” opportunity for sellers of oil to purchase the asset in the USA, sell it in Hong Kong, and generate a profit from the differential.
Cryptocurrency Arbitrage
Cryptocurrency arbitrage has become a sizable industry because of the ease with which crypto can be transferred between numerous exchanges.
Your standard crypto arbitrage loop looks like this:
- You have fiat (let’s call it US Dollars for this example) on Exchange 1. We’ll call this the “Buy Exchange”. Let’s assume you have $35,000 there.
- The float: You have Bitcoin on Exchange 2. For ease of reference, let’s call this “Sell Exchange”.
- In order to profit you need the price of Bitcoin to be cheaper on Buy Exchange than on Sell Exchange.
- When the price of Bitcoin is cheaper on Buy Exchange, you purchase Bitcoin using your US Dollars.
- Let’s assume those US Dollars bought you 1 Bitcoin, and you paid $35,000 for that.
- You would then sell exactly 1 Bitcoin (the same amount you bought on Buy Exchange) on Sell Exchange for a profit. If the differential is 5%, then you would sell the Bitcoin for $36,750 ($1,750 is 5% of $35,000).
- You started the process with $35,000 on Buy Exchange and 1 Bitcoin on Sell Exchange.
- You ended the process with 1 Bitcoin on Buy Exchange, and $36,750 on Sell Exchange.
- The final stages in this process are to send the Bitcoin on Buy Exchange over to Sell Exchange, withdraw the $36,750 from Sell
- Exchange into a fiat bank account and redeposit it into the Buy Exchange.
- You are now back where you started, but at $1,750 profit, minus a few transactional fees.
Arbitrage Trading in Crypto
There are a number of ways this kind of arbitrage happens in crypto. Most of them are automated using algorithmic trading bots.
Crypto users will have their API keys from Exchanges 1 and 2 plugged into their arbitrage trading bot. The moment the trading bot detects a large enough price differential, it will execute the purchase on Exchange 1 and the sell on Exchange 2.
In many cases, the trading bot will automatically “rebalance” the assets by withdrawing the Bitcoin back to Exchange 2, and the fiat back to Exchange 1.
Equalised Markets
In some cases, digital currencies that merely represent fiat are used (like USD Tether), so there is no need to withdraw and redeposit fiat. This is far less common, because these markets are already very well “equalised”. The price of Bitcoin will be almost exactly the same across the board.
Cryptocurrency Demand
Most crypto arbitrage exists in economies where Bitcoin and cryptocurrency are in much higher demand. This demand could be driven by things like the need for cross-border remittance, foreign exchange controls, or weak currency where citizens invest in crypto in much larger quantities than other parts of the world. This creates a crypto price premium in their home country.
Crypto Arbitrage Opportunities
With countless crypto exchanges around the globe, there exist many arbitrage opportunities– but finding them, analysing them, and executing on them is the challenge. Keep an eye out, because you never know what opportunities may present themselves!
But remember: Always invest wisely, and do thorough research before you do.
We’re here to assist you at MEX Digital, and if you require any further info, visit our FAQ section, or browse our blog. Alternatively send us an inquiry through our Contact Us form.
Remember, proper diligence and sound judgement should be used in evaluating the risks associated with these activities. Trading cryptocurrency carries significant risk and losses can exceed deposits. Refer to our Terms and Conditions and disclosure material.
