In trading, you may have heard the term Arbitrage. This term is generally known as a strategy used in a market. But what is it exactly? Let’s read in more detail below.
What is Arbitrage?
Arbitrage is a trading strategy that aims to take advantage of price imbalances in two different markets. A person who conducts arbitrage is called an arbitrageur. The challenge faced by arbitrageurs is not only finding differences in prices but also being able to trade them quickly. Because other arbitrageurs can see the difference in price (spread) fast so that the arbitrage opportunity can also be taken quickly.
To arbitrate, arbitrageurs generally buy crypto on a market that sells crypto at a low price. Usually, an arbitrageur has several accounts on several different exchanges. They also have assets in both accounts, so when they want to arbitrate, an arbitrageur doesn’t need to send crypto between exchanges.
But there are also other types that are usually implemented by arbitrageur, let’s discuss in paragraphs down below.
Types of Arbitrages
There are various types of arbitrage that traders can use. But specifically for cryptocurrency trading, the two types below are the most commonly used:
The price of crypto assets always changes rapidly. As a result, for any given crypto assets, there are always price discrepancies between exchanges. This is where exchange arbitrage is often used. Arbitrageurs exploit these price discrepancies by buying the same asset on an exchange where the price is cheap and sells it on another exchange at a higher price.
For example, if the price of BTC on exchange X is IDR 150,000,000, and the price of BTC on exchange Y is IDR 151,000,000, an arbitrageur can buy 1 BTC on exchange X and sell 1 BTC at exchange Y to pocket Rp 1.000.000 profit (before counting transaction fees).
Triangular arbitrage is also a common type of arbitrage in the crypto world, a trader finds the price difference between three crypto assets and exchanges them with each other triangularly. Basically, this strategy tries to take advantage of price differences across currencies.
For example, an arbitrageur can start with BTC, then uses the BTC to buy ETH, then use that ETH to buy BNB, then sell BNB to get more BTC than he/she originally owned.
Risk in Arbitrage Trading
Arbitrage is a low-risk trading strategy, but it needs carefulness because the imbalance in prices usually only occurs in a short time. This is because the market at large and the individuals in it will always move prices towards the equilibrium point. In fact, for markets with high liquidity, many professional traders are competing to arbitrage between markets using bots, so arbitrage opportunities can disappear within minutes or seconds. Other than that, in arbitration, an arbitrageur needs to take into account the transaction costs charged by each exchange to calculate profit/loss.
Arbitrage is widely used by traders because it is considered a great opportunity to earn profit without having to bet on the long-term price direction of an asset. In order to do this strategy, an arbitrageur requires executional speed and the right amount of funds to make profitable trades. That being said, traders need extra care when conducting arbitrage and consider all the trading fees and short-term price volatility into equation.