If somebody has lured you with the arbitrage bot candy bar, you might be wondering what that means. In short, an arbitrage bot helps you find price discrepancies, but where exactly and how?
The answer is right here.
What is arbitrage?
Just to be clear on the details, you need to understand what arbitrage means. First, be aware that there are different kinds of arbitrage, but essentially, it originates from traditional stock exchanges and exists as a result of market inefficiencies.
Arbitrage is the purchase and sale of an asset in order to profit from the difference in the asset’s price on different markets or in different forms.
For example, when performing stock-futures arbitrage, you buy stock for cash and sell it in the futures market. The difference in price might turn into a risk-free trade.
Since the cryptocurrency market is even more inefficient, it makes it the perfect place to implement arbitrage trading. In this piece, we’ll take a look at those arbitrage types that are commonly used in crypto: cross-exchange arbitrage and cross-asset arbitrage.
Cross-exchange arbitrage bots
Cross-exchange arbitrage is a kind of arbitrage trading where your bot makes profits on market inefficiencies between different exchanges.
This means that the crypto arbitrage bot sells high on one exchange and buys lower on the other, executing two orders simultaneously.
The mechanics for this kind of arbitrage are pretty straightforward, or, at least used to be a few years ago when prices for crypto assets on top of different exchanges tremendously varied.
These days, it’s harder to find opportunities for this kind of arbitrage manually since the spread narrowed, so this is where crypto bots enter.
For instance, as of writing this, on top of Bitfinex, your crypto bot could have purchased one Bitcoin for $6,876 to sell it for $6,881 on top of Kraken. While using an arbitrage bot, you should know that it also considers exchange fees.
At the end of the day, it’s not much of a profit, is it? A lot of small deals the cryptocurrency bots close could have brought more revenues. But as we’ve said, these days opportunities are harder to find.
Triangular arbitrage bots
Triangular or cross-asset arbitrage is a type of arbitrage where the bot scans for price discrepancies in pairs on top of one exchange.
In essence, this strategy implies that the price of an asset might vary in different pairs, and this is what you can make a profit on.
Let’s consider an example where you want to earn more Ether (ETH). How can your trading bot do that?
Say, you trade on top of Bitfinex. First, the bot will buy another asset with your Ether, say, LEO. Later, with your LEOs, it will purchase one more position, say, EOS, and after that, it will buy back Ether.
The profit might be insignificant, but to close a set of such small deals is a prerogative for your triangular arbitrage bot, and it will probably do so.
The work is boring and mundane. If you did it all manually, it would take you a million years to analyze multiple pairs and find all the discrepancies in them.
To sum up
Arbitrage is a trading strategy that originates from traditional markets and works in the realm of market inefficiencies. This is the reason why the crypto market is good enough for arbitrage bots to work it.
There are two types of arbitrage bots common for crypto markets: the cross-exchange arbitrage bot that explores price differences on top of different exchanges and the cross-asset arbitrage bot scanning for price discrepancies in pairs on top of one exchange.
If you’re still not sure about this kind of crypto bot, there are several pros and cons to it, but in essence, you should take into account that it is slightly harder these days to find arbitrage opportunities than it was a couple of years ago.