Fair-Bits Presents – What is Arbitrage?
You have probably heard about arbitrage before. Often shortened to ARB, this includes simultaneously buying and selling identical assets. This gives traders the opportunity to take advantage of a mismatch in their prices which is what everyone dreams of, right?
Taking advantage of market inefficiencies, this type of trade earns profit. And when there’s a price gap in different markets for the same financial securities, that’s the chance to pounce. Arbitrage involves making a risk-free profit from price discrepancies in the simplest possible terms.
Arbitrage can sound simple but it can be quite a challenge to find the right arbitrage opportunity and conduct it skillfully. That said, the strategy has huge advantages, such as the low or non-existent risk to the trades.
Arbitrage can be performed on any commodity that trades on at least two exchanges for varying sums. Financial securities, foreign exchange, gold and other metals, short-term interest rates, stocks, and even cryptocurrencies may do that. There will be arbitrage opportunities where there are several markets dealing in the same securities.
Why arbitrage trade?
And why would you put an arbitrage strategy into practice? Well the number one advantage that ARB plays is the lack of risk. Now, that doesn’t mean the strategy is risk-free. What it means is that in performing arbitrage there is less inherent risk than in holding an asset long-term.
This is because arbitrage is achieved quickly and your cash is only exposed to market forces for the fraction of a second it takes for the deal to be completed. Another advantage is that the money earned in good arbitrage transactions is assured as long as the plan is properly executed.
Or in simple terms: If you act on them as soon as you see the difference, ARB plays are risk-free.
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Two Ways to Succeed
There are 2 main ways to succeed with arbitrage:
- Processing a large number of transactions
- Processing fewer transactions which are larger
The price gap that ARB takes advantage of can be tiny and you really need to have scale to capitalize on these types of opportunities to the full.
So either you have to find a lot of them (something a trading bot will help you do) and make a small amount of money on each one, or you have to find some major opportunities and go all-in to win big on them.
Crypto Arbitrage Strategies
First, let’s lay out a basic strategy for crypto-arbitrage in which the arbitrator aims to exploit price discrepancies of the same asset in different markets.
In this case, on two different exchanges, the trader notices a price difference for the same token. He or she is buying the token from the exchange on which it trades lower. He then sells it for higher up on the market the crypto sells.
Through leveraging the price gap the trader is pocketing a riskless income. This strategy is fairly straightforward and requires no further trades than those necessary to swap the two cryptocurrencies.
Second, with crypto, we should lay out a somewhat more complicated but worthwhile and profitable strategy: triangular arbitrage. Triangular arbitrage is relatively easy to apply it to crypto.
Triangular arbitrage of crypto-assets involves analyzing the exchange rates between three different crypto-assets to identify anomalies from which the arbitrator, like any other asset, may profit.
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