What is Arbitrage Trading?
Arbitrage trading is a trading strategy that takes concern of profiting from different exchange rates of various markets. Essentially, the tactic relies on the factor of market inefficiency, which refers to a situation when different markets display varying values for an identical asset. Traders engaged in this strategy are referred to as arbitrageurs, which operate on more than one market for the purpose of maximum profit gains over differentiating asset values.
Arbitrage trading can take numerous forms, depending on the asset and situation at hand. In cryptocurrency, the most common form found is Exchange Arbitrage.
Exchange Arbitrage is a strategy involving benefiting off of crypto market inefficiencies, wherein an asset’s value can be displayed at different price points on various exchanges.
An arbitrageur would compare the exchanges’ prices and profit through the purchase of an asset on an exchange providing lower value and selling it on another with a higher-market value.
Examples of Exchange Arbitrages
Let’s say Exchange A is selling Bitcoin at 2,000,000 Baht per pop, while Exchange B is selling the coin for 2,001,000 Baht simultaneously.
When the price difference is recognized, a trader would be able to perform arbitrage trading on exchanges by buying BTC on Exchange A at 2,000,000 Baht and transferring the coins over to Exchange B, where it is sold at 2,001,000 Baht, acquiring a profit of 1,000 Baht per BTC sold.
*Note: This calculation has yet to include the transfer fees between exchanges.
Benefits of Arbitrage
The technique is a rather low-risked method that aims towards benefiting off the price gap between various exchanges, meaning the price movement is not taken into regard as a risk.
With low risks come bots and increased usage of the technique. Their presence can boost the overall activeness of markets as arbitraging can enhance market efficiency, further shortening the gap between prices of each exchange, while also increasing the liquidity rates.
Therefore, this means the more this strategy is used, the less a market is found to be inefficient, further making arbitrage trading more difficult to perform.
Downsides of Arbitrage
Though the technique can be rather non-risky, when compared to other methods, execution risks and liquidity risks are still present.
Execution risks are found when arbitrage trading, wherein the time consumption of executing the strategy can be longer than expected, rendering the technique ineffective and the trader at loss instead.
As for liquidity risks, they are essentially the damaging effects of a market with low liquidity, making arbitrageurs unable to sell their assets at a desired price point, coercing them to take loss, rather than profit.
Other than the two, another risk that should be taken into consideration is the exchange rate or transfer fees inducted when transferring cross-exchange. Its calculation in an equation is important as it could easily cause slippage in a trader’s calculations.
Though the technique is rather low-risk and not complex, its execution can be risky as numerous factors come into play when cross-transferring funds. Hence, investors are highly advised to make intensive research, while also assessing their risks before performing any methods.