How does arbitrage work?

Profit from market inefficiencies with Cryptohopper's arbitrage bot, trading without fund transfers between exchanges.

Pete Darby avatar
Written by Pete Darby
Updated this week

The definition of Arbitrage: "Arbitrage is the simultaneous purchase and sale of an asset to profit from a price difference".

It is a trade that profits by exploiting the price differences of crypto exchanges or market inefficiencies. Arbitrage exists as a result of market inefficiencies and would not exist if all markets were perfectly efficient.

Exchange Arbitrage

Prices between crypto exchanges and pairs can be different, due to supply and demand. Make use of those price differences without the need to withdraw your funds from your crypto exchange!

The arbitrage bot on Cryptohopper does not send funds among different exchanges (as you might expect from Arbitrage). Therefore, we don't need permission for "withdrawal rights" through the API.

But if you don't withdraw your funds, how does it work?

To do exchange arbitrage, you need to own the coins for which you would like to Arbitrage. For example, your quote currency is USD, and you have seen that normally ADA, ATOM, and EOS are prone to offer arbitrage opportunities among certain exchanges. Then, you will need to have all these coins on two (or more) exchanges you want to do Arbitrage on. Now you are set and ready to start taking advantage of price inefficiencies.

Let's analyze how this mechanism works. Let's imagine an arbitrage opportunity between USD (your base coin) and EOS (the coin offering the arbitrage opportunity):

  1. You own USD and EOS on exchanges A and B.

  2. On exchange A, the price of EOS is 3.10, and on exchange B it is 3.02. Therefore, there is an arbitrage opportunity since EOS is more expensive on exchange A.

  3. A manual arbitrage trade will consist of buying EOS on exchange B and selling it for a higher price on exchange A back to USD. Then, your portfolio would result in a USD gain.

An automated Cryptohopper arbitrage trade would do it differently but results in the same USD gain. Let's recall that you own USD and EOS on both exchanges. As we know, the goal is to keep the same amount of EOS while increasing your total USD amount.

Since you want to increase the amount of USD, you would, for example sell 2000 (expensive) EOS on exchange A (for USD). At the same time, you would also buy 2000 EOS (cheap) on exchange B to maintain the same amount of EOS you had before the trade. It could happen that one of your funds of a specific coin is depleted on one of your exchanges, then it will be necessary to move funds manually from one exchange to another to start the process again.

Market Arbitrage (Triangular Arbitrage)

The Market Arbitrage bot will look for market inefficiencies within one exchange.

Your bot will attempt to increase the amount of the coin(s) you have selected as base coin. It will do this by taking advantage of price differences between the currencies available on your exchange. More specifically, it will make three different trades to increase the amount of the chosen base coin. Market Arbitrage works best on exchanges with lower trading volumes.

For example, say that you have BTC as base coin. That bot has found a market arbitrage opportunity that includes the coins Ethereum and Litecoin.

  1. First, it will buy Ethereum (48 ETH) with Bitcoin (1 BTC) on the exchange (sell Bitcoin).

  2. Secondly, the Ethereum (48 ETH) the Hopper has just bought is used to buy Litecoin (153 LTC).

  3. The final step is to buy back Bitcoin (1.005 BTC), completing the triangle and increasing the initial amount of Bitcoin.

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