Crypto Wiki: Arbitrage

Arbitrage could be one of the lowest risk investment opportunities that you can find, because it relies more on established events than predictions.

It's often possible to see very small differences in the price of the same asset between two or more markets. This discrepancy obviously creates buying and selling opportunities for canny investors, who can buy low and sell high (if they are quick enough). The name of this practice is Arbitrage.

Arbitrage inadvertently acts as a unifying force because it encourages prices for the same or similar assets to converge across markets, and the speed at which this happens can be taken as a yardstick of general market efficiency.

If all markets were working at optimal efficiency then you'd see the same price for an asset at every exchange. They would always be identical and there wouldn't be any chances for the trader to profit from arbitrage, but of course, this isn't the case.

In theory, arbitrage potentially offers you the ability to profit without risk, since you aren't gambling on the outcome of a future price move. You already know the difference between two prices on separate exchanges for an asset, and you try to take advantage of it.

That's the theory, but in reality, the markets are full of any number of dedicated bots looking to do exactly that, and their activities may affect price moves and thus your level of risk.

In order to use arbitrage with cryptocurrencies, it's best not to be dependent on blockchain transactions. For example, a trader wishing to use arbitrage with bitcoin across a pair of exchanges would necessitate them opening accounts in each of them. Also, to avoid the typical half-hour wait times that deposit and withdrawal confirmations can take, it's best for the trader to have accounts with both exchanges, and each of them stocked with enough funds to facilitate immediate transactions.

When they're talking about arbitrage, the approach that we just described is the type that most traders will know and it's called "pure arbitrage", but there are actually around 10 more types you can use.

One example (which isn't quite as popular) is merger arbitrage. This method relies a lot more on speculation because it's concerned a lot more with how future events will affect an asset's price. We're specifically talking about things like company acquisitions, mergers, bankruptcies, and so on.