Arbitrage refers to purchasing and liquidating assets across multiple markets to capitalize on price discrepancies. For example, a trader might acquire a specific asset in one market and promptly offload it in another market at a more profitable rate.
Arbitrage opportunities arise due to market inefficiencies. This implies that the same asset can have varying trading prices in different markets, even though both markets are trading identical assets (or extremely similar ones).
In financial trading, arbitrage plays a crucial role as it inhibits the formation of substantial price differences among comparable or identical assets across various markets. Consequently, arbitrage operations depend on minor price discrepancies and typically lead to a convergence of prices. The rate at which this convergence transpires can serve as an indicator of the market’s overall efficiency. In an ideally efficient market, there would be no arbitrage opportunities since every tradable asset would maintain an identical price on all exchanges.
Arbitrage is a riskless method to profit from temporary price differences if executed properly. However, it’s important to remember that various markets are operated by trading bots, many of which are specifically programmed to exploit arbitrage opportunities. Consequently, arbitrage trading may carry certain risks depending on the strategy and implementation.
Capitalizing on arbitrage opportunities in cryptocurrency trading is most effectively achieved by circumventing reliance on blockchain transactions. For example, a trader aiming to arbitrage Bitcoin across two separate exchanges would be well-advised to maintain an account on each platform. Furthermore, both accounts must be sufficiently funded to facilitate immediate buying and selling, eliminating the need to depend on deposit and withdrawal confirmations, potentially exceeding thirty minutes subject to network traffic.
While a minimum of ten distinct arbitrage strategies exist, the term is commonly used in trading to refer to the traditional form, also known as pure arbitrage. This strategy is based on identifying market inefficiencies and price differences rather than on speculation, making it generally viewed as a low-risk method.
An alternative, less widely used method is known as merger arbitrage, also called risk arbitrage. This highly speculative strategy depends on a trader’s anticipation of a future event influencing the asset’s price. Such events could encompass corporate acquisitions, mergers, or bankruptcy declarations.
