Explaining arbitrage in an easy-to-understand way: a mechanism for generating profit from price differences in the market.

What is an arbitrageur

Arbitrage (arbitrageur) is a trading strategy that profits from the price differences of the same asset in multiple markets. In simple terms, it involves buying an asset at a lower price in one market and selling it at a higher price in another market, thus making a profit from the difference.

The background for this transaction's establishment lies in market inefficiencies. Theoretically, even if it is the same asset, it can be traded at different prices in different markets, and such price differences (price gaps) become the target of arbitrageur.

Why do price differences occur?

The mechanism of price differences between markets is related to market efficiency. In a completely efficient market, the same asset should have the same price across all exchanges. However, in reality, price differences arise due to factors such as imbalances in trading volume, differences in liquidity, network delays, and variations in regulatory environments.

The activities of arbitrageurs actually serve to reduce these price discrepancies. By buying in the cheaper market and selling in the more expensive market, the prices in both markets eventually converge.

How to Practice Arbitrage in the Cryptocurrency Market

When conducting arbitrage in the cryptocurrency market, it is efficient to minimize remittances via the blockchain network. For example, when executing Bitcoin arbitrage between two different centralized exchanges, it is important to have sufficient funds prepared in advance on both platforms.

This allows you to execute buy and sell orders instantly without being affected by the waiting time for deposit and withdrawal approvals (which can take more than 30 minutes during network congestion).

Risks and Real-World Challenges

Arbitrageur may seem like a “no-risk” trade at first glance. However, in the current market environment, many automated trading bots are implementing arbitrage strategies, and many of them are highly optimized.

As a result, the price differences quickly disappear compared to before, and the time window for individual traders to make a profit has become extremely limited. It should also be noted that depending on the execution method of the strategy, there are risk factors such as fees, slippage, and exchange restrictions.

Two Main Approaches to Arbitrage

The most common arbitrage strategy is the aforementioned “simple arbitrage.” This method is not speculative and is considered to be relatively low risk as it takes advantage of objective market price discrepancies.

On the other hand, “merger arbitrage” (also known as risk arbitrage) is a more speculative approach that involves predicting future events such as corporate acquisitions, mergers, and bankruptcy filings. This type has a high level of uncertainty regarding price fluctuations and requires appropriate risk management.

To put it simply

To understand arbitrage succinctly, it is “trading that takes advantage of temporary price distortions between markets.” It also functions as a move to enhance overall market efficiency and plays a crucial part in the automatic adjustment mechanism of financial markets. However, to actually make a profit, it is necessary to meet several conditions such as precise execution timing, sufficient capital, and a low-fee environment.