There are a huge number of ways to generate income in the cryptocurrency market – from low-level fraud to multi-billion dollar businesses. It is easiest for an ordinary participant to get into trading. Trading also has several directions:
Long-term (together with investments)
Today we will take a closer look at what arbitrage is, why it is extremely important to know and take into account about it, and we will also figure out how to make money on it.
Exchange arbitrage is a way to make money in the market by eliminating price inefficiencies on one of the pairs of assets.
In recent years, arbitration has become more and more algorithmic, and it has become increasingly difficult for a person to make money on it. There are several types of arbitrage, but it can be divided into two of the most popular: intra-exchange and inter-exchange.
Since the price for a specific pair of a specific asset is the last executed market order, and its price is determined by supply and demand, there are times when there is a demand for one pair of an asset, but not for another. Accordingly, the price of one pair of the same asset is flying up, and the price of another pair of the same asset is standing still, or even falling. This is an example of standard market inefficiency.
At this moment, such a pair becomes interesting for intra-exchange arbitrage algorithms. They buy an asset in a cheap pair and sell it in an expensive one. Until the price is equal.
As everyone knows, every pair has limited liquidity. It is a limitation in earnings on arbitration.
But what if the situation with different asset prices occurs on different exchanges?
The game includes inter-exchange arbitrage.
Here is a simplified diagram of how it works:
The algorithm has deposits on two exchanges. 50% in fiat, and 50% in the coin, the price of which the arbitrage will presumably equalize. When the price of an asset / selected pair starts to differ on one of the exchanges, the algorithm buys where it is cheaper and sells where it is more expensive. Thus instantly eliminating the price difference.
Why is it important for a trader to recognize arbitrage?
The point is that usually, the anomalies provided by the arbitrage opportunity do not just happen.
First of all, they are formed due to abnormal limits or market orders (provided that the exchange is not low-liquid).
This means that such an anomaly in conjunction with arbitrage can create anomalous price movements, an abnormally large volume, or just strange behavior of the pair. All this can lead to errors in the analysis, or simply slippage of the stop due to reduced liquidity on the pair.
Arbitrage is a very complex and competitive way of trading, the income ceiling of which rests on the liquidity of anomalies.
This way of trading is not suitable for beginners, but pros can easily combine their usual trading strategies with global anomaly arbitrage.
In recent years, there have been too many of them to ignore such earnings.