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Crypto Arbitrage Opportunities: All About Cross-Asset And Exchange Arbitrage!

Arbitrage refers to the behavior of investors taking advantage of the imperfection of the market economic price system to obtain profits. Arbitrage can help financial markets operate efficiently, and inject more liquidity into the market.

Various arbitrage mechanisms exist. In theory, almost all of them can achieve arbitrage; however, in actual arbitrage operations, there may be many risks involved, and profits can often be eroded due to the various fees involved in the arbitrage process.

Arbitrage opportunities have been continuously repressed in the traditional financial market — due to the market’s maturity and agility of the trading system, there are usually very tight time windows for arbitrage to be successfully carried out.

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Arbitrage opportunities, however, are much more prevalent in the cryptocurrency industry versus the traditional financial market. As the former is still in the relatively early stages of development, less stringent regulatory measures coupled with silo-ed trading systems present abundant windows for arbitrage.

This article introduces the two main forms of arbitrage: cross-asset arbitrage and exchange arbitrage.

This article introduces the two main forms of arbitrage: cross-asset arbitrage and exchange arbitrage.

🔹Cross-Asset Arbitrage

Cross-asset arbitrage, also known as triangular arbitrage, refers to the arbitrage behavior that occurs between two trading pairs formed against three assets on an exchange.

🔹Let us take asset F as an example.

Assuming a cryptocurrency exchange offers two trading pairs involving asset F: F/BTC and F/ETH. At a particular point in time, the price of F/BTC could be US$11 while the price of F/ETH is US$10. A trader with US$100 worth of ETH will be able to arbitrage following the steps below:

1) Use US$100 worth of ETH to buy asset F in the F/ETH trading market at a price of US$10 = to obtain 10 F (valued at US$100);

2) Sell 10 ​​F at the price of US$11 in the F/BTC trading market and obtain BTC valued at US$110;

3) Exchange BTC for ETH to obtain US$110 worth of ETH;

4) A profit of US$10 (US$110 — US$100) is obtained in such a scenario.

🔹Under ideal circumstances, successful cross-asset arbitrage can be realized without risk. However, various real-world factors exist to erode profits from cross-asset arbitrage. A few reasons are:

Transaction fees. A high transaction amount would likely involve high transaction fees that could greatly reduce arbitrage profits.

Limited asset types. Assets with multiple trading pairs that can be used for triangular arbitrage are generally limited to mainstream assets.

Liquidity. Successful cross-asset arbitrage would require exchanges with high liquidity levels. An exchange with poor liquidity would not be able to fully fill arbitrage orders.

🔹Exchange Arbitrage

Exchange arbitrage refers to the arbitrage behavior of purchasing cryptocurrencies at a lower price on one exchange and selling them at a higher price on another exchange to profit from the price difference.

The price of an asset may vary slightly across different exchanges. When the market fluctuates violently, the rise or fall of an asset’s price often starts with a certain exchange. Arbitrageurs will then be attracted by the subsequent price differences between various exchanges. Finally, such price differences will be smoothed out by exchange arbitrage behaviors.

Exchange arbitrage is limited by the fund transfer time on a certain blockchain and a cryptocurrency exchange’s processing time. When a price difference for the same asset occurs between exchanges, arbitrageurs need to buy at a low price within a short window of time and transfer it to an exchange where it is priced higher to make a profit. However, if the blockchain network is congested (for example, the Bitcoin and Ethereum networks are often congested) or an exchange takes too long to process transactions, timely arbitrage will fail, resulting in the loss of profits.

To counter such potentially debilitating factors, most institutional quantitative investors store a large amount of various cryptocurrencies in various exchanges in order to facilitate quick capitalization of arbitrage opportunities. Such a strategy, however, could also result in losses arising from funds sitting idle, so investors are encouraged to seek the right balance between risk and opportunity.

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See you next time Huobi community!

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