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Types of Crypto Arbitrage Strategies

Cross-exchange arbitrage: Buying crypto on one exchange to sell on another.
Spatial arbitrage: Same as above, but exchanges are located in different regions.
Triangular arbitrage: Trading loops and moving funds between two or three digital assets to capitalize on price discrepancies of one or two cryptos.
Decentralized exchange: Arbitrage involves the use of smart contracts and is done on or across decentralized exchanges.
Statistical arbitrage: This cryptocurrency arbitrage bot relies on mathematical models and trading bots. It uses econometrics, statistical, and computational techniques to trade crypto.
Spread arbitrage relies on price spreads between buying and selling prices across exchanges.

Triangular arbitrage

Triangular arbitrage is the result of a discrepancy between three foreign currencies that occurs when the currency’s exchange rates do not exactly match up. These opportunities are rare and traders who take advantage of them usually have advanced computer equipment and/or programs to automate the process.

A trader employing triangular arbitrage, for example, would exchange an amount at one rate (EUR/USD), convert it again (EUR/GBP), and then convert it finally back to the original (USD/GBP), and assuming low transaction costs, net a profit.(2)

International banks, who make markets in currencies, exploit an inefficiency in the market where one market is overvalued and another is undervalued. Price differences between exchange rates are only fractions of a cent, and in order for this form of arbitrage to be profitable, a trader must trade a large amount of capital. (2)

Example of Triangular Arbitrage As an example, suppose you have $1 million and you are provided with the following exchange rates: EUR/USD = 1.1586, EUR/GBP = 1.4600, and USD/GBP = 1.6939.

With these exchange rates there is an arbitrage opportunity:

Sell dollars to buy euros: $1 million ÷ 1.1586 = €863,110 Sell euros for pounds: €863,100 ÷ 1.4600 = £591,171 Sell pounds for dollars: £591,171 x 1.6939 = $1,001,384 Subtract the initial investment from the final amount: $1,001,384 – $1,000,000 = $1,384 From these transactions, you would receive an arbitrage profit of $1,384 (assuming no transaction costs or taxes). (2)

By exploiting market inefficiencies, however, the act of arbitraging brings markets closer to efficiency.

Arbitrage can be used whenever any stock, commodity, or currency may be purchased in one market at a given price and simultaneously sold in another market at a higher price. The situation creates an opportunity for a risk-free profit for the trader.

Centralized order book vs Automated Market Makers arbitrage

The price of an asset pair on a Centralized Order Book is determined by individual market makers creating buy and sell orders while other participants decide if they want to trade at those given prices. [4]

On the other hand, Automated Market Makers use a mathematical formula to define the price depending on each asset’s balance deposited on the liquidity pool. [4]

It is interesting to notice that the only way for the price to move on an AMM is when a swap happens, therefore, arbitrageurs become the main force in helping the AMM keep the price close to all the other markets. [4]

To conclude a profitable arbitrage transaction, speed is critical. On the Ethereum for example, every transaction participates in an auction, where the users compete to see who will pay more to have their transactions validated first. If you set your gas price too high, your transaction will be processed faster, but you risk overpaying for it and increasing the cost of executing the arbitrage. If you set your gas price too low, you will save on transaction costs, but you risk taking too long to complete the transaction and missing the profitable arbitrage opportunity.

The concept of arbitrage trade is easy to understand: Buy low at one market, sell high at another simultaneously with a price difference significant enough to cover the costs, and have a profit margin.