Arbitrage trading seeks to profit from temporary market inefficiencies that result in the mispricing of the same asset in different markets or between different brokers or similar assets in the market.

Arbitrage trading helps to quickly correct such temporary pricing inefficiencies by correctly adjusting prices across multiple markets, brokers, or different forms of the same asset or financial instrument.

Temporary imbalances that create opportunities for arbitrage trading provide an opportunity to simultaneously buy and sell a trade that makes a small profit as a result of price fluctuations.

For example, in the forex market, there may be a temporary small discrepancy between the EUR/GBP exchange rate and the two currency pairs EUR/USD and GBP/USD, which may allow a trader to profit from selling. EUR/USD at the same time, and buying EUR/GBP and GBP/USD.

Another example of an arbitrage trading opportunity is when different brokers offer slightly different bid-ask spreads, offering the opportunity to simultaneously make a small profit at one broker's lower trading price while simultaneously selling an asset at a lower trading price.

What is Crypto Arbitrage?

Traditionally, arbitrage trading refers to the transfer of funds from countries or regions with lower interest rates to countries or regions with higher interest rates for investment by taking advantage of short-term interest rate differentials in different countries or regions.

Automated Arbitrage trading in the futures market refers to the simultaneous buying and selling of two different types of futures contracts and in the cryptocurrency market, it refers to taking advantage of differences in the prices of cryptocurrencies on different cryptocurrency exchanges.

Crypto arbitrage bots can do this fully automatically and continue round neutrality without interruption. Using a cryptocurrency trading bot is very important in this regard, as constant monitoring and quick decision-making are key when it comes to cryptocurrencies and the highly volatile cryptocurrency market as a whole.

Why is crypto arbitrage so common?

Several features make digital currency a profitable asset class for arbitrage traders. Cryptocurrencies are not tied to real-world commodities, governments, or corporations, meaning there are no central authorities that can clarify what a digital token should be traded for. The decentralized nature of cryptocurrencies makes them more prone to price fluctuations across multiple markets.

Also, because crypto is decentralized, it is more volatile than other asset classes. Price volatility in cryptocurrencies is generally higher than in traditional markets such as equity markets. Also, since the crypto market cap is lower than markets like bonds or precious metals, it doesn't take much money to move these tokens up or down.

Types of Arbitrage Trading Strategies

Arbitrage trading can be as simple as exchanging a token between two exchanges. However, there are some complicated ways in which arbitrage traders try to make a profit. Here are three:

       Cross Exchange Arbitrage – This first technique is “standard” arbitrage trading. With this strategy, one buys a token at a low price on one exchange and sells it on a second exchange for a profit. In crypto, neutrality can occur between exchanges on both CEX and DEX.

       Spatial Arbitrage: Spatial arbitrage attempts to take advantage of price differences for the same asset in different regions. The most famous example of space arbitrage in crypto is South Korea's "Premium Kimchi". Crypto markets in South Korea are famous for selling Bitcoin at higher prices compared to exchanges in other countries.

While it may seem simple to sell Bitcoin for profit in the Korean crypto markets, arbitrage traders must take into account foreign exchange fees and exchange rates between their fiat currency and the Korean Won. Also, now that more people are aware of this premium, regulators are keeping a close eye on suspiciously large transactions.

       Triangular Arbitrage – Triangular arbitrage is commonly used in the foreign exchange (FOREX) market to profit from the price differences of fiat currencies. However, some cryptocurrency traders use this system to exploit price discrepancies on the same trading platform.

This trade is called "triangular" because it involves three parties and ends where it started. Traders first exchange one cryptocurrency for another that is undervalued on the trading platform. The trader will then sell this low-value token for high-value crypto. Finally, the trader will sell this third token back to the initial cryptocurrency level.

Conclusion

Crypto arbitrage is a legitimate business practice and plays an important role in the financial markets. In fact, it is doubtful that DEXs like Uniswap would do well without arbitrage trading. Having little experience in cryptocurrency trading can make it easy to quickly lose your funds on a poorly executed arbitrage trade.