Same Asset, different prices
Markets, including both stock and cryptocurrency exchanges, exhibit inefficiencies due to various factors such as differing access to information, transaction costs, and human psychology. These inefficiencies often lead to price disparities for the same asset across different markets.
Arbitrage traders capitalize on these price differences by swiftly buying an asset in a cheaper market and selling it in a market where it has a higher price. Same asset, different markets.
Importance of Arbitrage
By exploiting these inefficiencies, arbitrageurs not only make profits, but they also equalize prices across exchanges, thereby enhancing market efficiency and liquidity flow.
Arbitrage is essential as it prevents assets from deviating from their fair value for extended periods. Executing arbitrage involves minimal price risk, as traders buy and sell the same quantity in different markets. Nevertheless, there are still some minimal risks associated with the need for near-instantaneous execution and trading costs, including commissions.
Arbitrage trades can involve two or more markets and assets, ranging from straightforward transactions like buying Bitcoin at a lower price on one exchange and selling it for a higher price on another, to more complex strategies like triangular arbitrage involving three different assets in three markets.
Technological advancements, such as automated trading, have made it harder to execute arbitrage trades. Nonetheless, as long as markets remain imperfect and inefficient, arbitrage will continue to play a crucial role in ensuring market fairness and efficiency.
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