Arbitrage Trading – Beginner’s Guide

introduction

When you consider your investments, the chances of profits and losses are everywhere. It is difficult to believe that there is an option to offer almost 100% chance of profit and near zero risk. But such options exist. It is called an arbitrage transaction. An arbitrage is the simultaneous buying and selling of securities, currencies, cryptocurrencies, or goods in different market or derivative formats in order to utilize different prices of the same asset.

The concept has become simpler

To understand the concept from examples, take a closer look at the market and observe that there is a slight difference in the price of $BTC for Binance and Coinbase. Since cryptocurrency prices must be the same on all exchanges, exchanges offering low prices must have temporary glitches and we know that prices will soon match the higher version. Take advantage of the price gap by buying at a lower price and selling at a higher price.

How arbitrage trading works

However, this process raises many question marks. You may consider whether it is possible for traders to shift assets between exchanges very quickly. Also, is there no transfer fee when assets are shifted? If these charges are added to the exchange’s trading fees, can traders still make something?

The answer to the first question is that the profit margins of arbitrage transactions are very small. Therefore, this option is generally only considered by a large number of traders in their investments. Even a very small number of very large investments are sufficient to make trade worthwhile. Such traders usually do not shift assets. They already have funds in many exchanges. They are bought and sold there through rebalancing.

This answer will automatically answer the second question. There is no such fee as the shifts are not involved. The third point is that while the transaction fees are certainly there, they do not interfere with the acquisition of profits. Such transactions are generally carried out by high frequency trading (HFT) companies that have sophisticated algorithms for this purpose. These systems work quickly and efficiently.

Speed of running arbitrage transactions is the most difficult thing. The difference in prices that traders see is visible to everyone, so there are many traders looking to take advantage of the opportunity.

Types of arbitrage transactions

There are three types of arbitrage transactions in the crypto market.

Replace Arbitrage

Observing the coin order book and comparing it with different exchange versions, there are very small differences. In fact, the type of arbitrage that has been discussed so far in this article is the exchange arbitrage. Suppose a trader is observing that $BTC is trading for $118,234 on Binance and $118,245 on Coinbase. As mentioned above, trading speed is very important. Because even a second delay can rob the traders of the profits they were targeting.

Funding Fee Transactions

Funding fees are a common arbitrage tactics used by cryptocurrency derivative traders. This involves keeping cryptocurrencies such as Ethereum, while simultaneously using opposite but equal positions to reduce price risks, using permanent futures. It aims to ensure consistent revenue from funding to maintain permanent contracts along the market.

Let’s imagine you will hold 10 Solana and plan to hold it in the long run, but you are worried about price volatility. Open a short position in the Solana Perpetual Futures contract to protect your investment from short-term price fluctuations. This short position moves in the opposite direction of Spot Holdings, so the loss on one side is covered by the gain on the other side.

If the funding rate for that futures contract is positive, then traders for a long time must pay a short person. As a short trader, you receive those payments. For example, if your funding rate is 1.5%, you can earn 1.5% in the value of your short position just to hold.

Your spot and futures positions are cancelled from each other in terms of price, so you are not exposed to market direction. Whether Sol goes up or down, profits on one side cancel the loss on the other side. Your net profit will come from paying your funding rate as long as it exceeds your transaction fees. Simply put, it converts 10 Sol into yield assets by neutralizing price risk and collecting regular payments from the futures market.

Please note that this trade will only benefit if leverage is not used.

Triangle arbitrage

Triangle arbitrage is another common crypto market strategy. This involves making the most of the price differences between the three different cryptocurrencies.

The goal of such a transaction is to profit from the inconsistency between the prices of three coins. For example, a trader starts by converting $sui to $btc, using that $btc to buy $eth, and finally reverts $eth to $sui. If the exchange rates between these pairs are not perfectly matched, traders may end up with more $SUI than they were in the beginning, creating risk-free profit opportunities. So, in addition to examining the $usdt pair, it is always useful to look up the $btc pair.

Conclusion

Arbitrage trading is probably the only option in the crypto market where you can expect a very low risk and almost 100% chance of profit. The condition is that it must be carried out quickly enough. Arbitrage, Funding Fees, and Triangle Adjudication are three forms of three common arbitrage transactions. The important points remain the same. It’s about taking advantage of different price differences for different exchanges, different coin pairs, or different price movements.