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Arbitrage… A fancy word you may have heard, but what is it?

ar·bi·trage ˈärbəˌträZH/ noun the simultaneous buying and selling of securities, currency, or commodities in different markets or in derivative forms in order to take advantage of differing prices for the same asset.

If you’re an avid Coinmarketcap surfer you may have noticed differing prices similar to those depicted below.

You might be thinking to yourself, can’t I make a profit if I simply buy it on Mercatox and sell it on Bit-Z? Well, you’re thinking right! That kind of execution, buying for low on one exchange and selling for high on another is called arbitrage. It is virtually risk-less. I use virtually because fluctuations in prices can ultimately make you lose money. This is why you need to execute the entire arbitrage transaction as quickly as possible, which means you need to buy at the highest ask or sell at the lowest bid. That is, buy at the highest selling price and sell at the lowest buying price.

Why does arbitrage exist?

Arbitrage exists as a product of several things:

Many markets Low liquidity

There are more factors but the two listed above are the main ones. As of writing, there are over 190 different cryptocurrency exchanges available to the masses. This spreads and segregates the total market of people buying and selling cryptocurrencies, resulting in lower liquidity (liquidity is the availability of assets in a market, how quickly you can buy or sell it). So, the less liquid the market is, the slower the movement of funds across these markets, subsequently slowing down the forces that drive prices together. This is why more liquid assets tend to have smaller price differences.

Why don’t prices converge?

Actually, that’s the whole principle of arbitrage. Differences in price across exchanges converge due to people we call arbitrageurs, they find and exploit these opportunities that ultimately force the prices across markets to converge. Why does arbitrage make prices converge? Remember when I said that arbitrage is virtually risk-less? Well, arbitrageurs want to minimize the risk they have to price fluctuations. To do this they have to execute the trade as quick as possible, meaning buying at the highest sell price and selling at the lowest buy price.

What does this tell us?

We don’t want to arbitrage coins that have LONG transaction times

We have to factor in withdrawal fees

We cannot simply look at “last trade” prices, we must look at the order book to determine if arbitrage exists

An example:

Let’s say you see USDT/BTC at the following prices:

Exchange 1: $10,000

Exchange 2: $11,000

What do we do?

Buy 1 Bitcoin for $10,000 Transfer my 1 Bitcoin to Exchange 2 (assuming instant transaction times) Sell it for $11,000 Profiting $1,000

Is there more?

The method I described above is only one version of arbitrage. There is more! Other techniques include the elusive Triangle Arbitrage and Square Arbitrage which I will describe in a future post.

Can I get in on the fun?

Yes you can! I’ve created an Google Sheets that helps you identify these arbitrage opportunities. I will be sharing this and how to use it in a future post.

Thanks for reading! This is my first post. If you liked it and would like to see more please let me know!

Happy arbitraging!

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