Crypto traders are always looking for a way to make a profit. Some engage in perpetual futures trading, and the more adventurous deposit digital currency in a crypto casino to facilitate gaming. However, the risk-averse crypto holders engage in an activity known as arbitrage trading.
To understand this form of trading, you’ll have to imagine a situation first. What if there was a way you could ensure that the trade you’re going to make will end up in profit? Surely, you’d have known beforehand the direction in which the market will swing. If you had that kind of power, you’d use it to the maximum.
Arbitrage trading is the closest thing to making correct market predictions. Arbitrage traders are seasoned rivals when it comes to entering these types of trades. Hence, the reason arbitrage trading is facilitated by high-frequency trading algorithms.
Arbitrage trading is a form of trading that seeks to pull quick gains by purchasing a financial instrument in one market and almost instantly selling it in another market. The financial instrument has to be identical, and the trade must occur on different exchanges.
The idea is to spot a price difference across two exchanges and then facilitate the trade. The major obstacle arbitrage traders face is getting wind of these price differences. The other key challenge is facilitating a quick trade since other arbitrage traders will likely spot and trade the price difference swiftly.
Practically, arbitrage trades come with low risk and low rewards. The trade size has to be substantial for the gains to be worth something.
The most popular type of arbitrage trading in crypto is exchange arbitrage. It involves spotting a price difference in the price of a cryptocurrency and facilitating its trade.
For instance, if the price of Bitcoin on one platform is slightly lower than the price of Bitcoin on another platform, the Bitcoin on the first platform is bought and then instantly sold on the second platform. This requires timely execution since crypto’s price is highly volatile and changes within microseconds.
This is a slightly more complicated form of arbitrage since it involves three cryptocurrencies. This trade can be made if a price difference is spotted between three digital currencies.
For instance, a price difference between Bitcoin, Ethereum, and Ripple could lead to a triangular trade. The Bitcoin could be used to purchase Ethereum, which is then used to buy Ripple, which is then used to repurchase Bitcoin, completing the triangle. This type of trading usually brings better profits.
Arbitrage trading has always existed in the financial markets and is now facilitated in crypto. It is a form of trading where traders quickly purchase and dispose of assets to make quick profits. In the crypto space, triangular and exchange arbitrages are the most common.