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How Arbitrage Works

What Is Arbitrage?

Arbitrage is basically buying a crypto currency on one exchange and simultaneously selling it on another at a higher price, profiting from a temporary difference in prices. This is considered riskless profit for the trader.

If all markets were perfectly efficient, there would never be any arbitrage opportunities - but markets seldom remain perfect. It is important to note that even when markets have a discrepancy in pricing between two equal currencies, there is not always an arbitrage opportunity. Transaction costs can turn a possible arbitrage situation into one that has no benefit to the potential arbitrageur.

How Does Arbitrage Make Money?

As a simple example of arbitrage, consider the following. Bitcoin is trading at $4000 USD on Bitstamp while, at the same moment, it is trading for $4010 on Bitfinex. A trader can buy bitcoins on Bitstamp and immediately sell the same amount on Bitfinex, earning a profit of $10 per bitcoin.

More complicated arbitrage strategy in use is triangular arbitrage. It is a little more difficult to understand than the above example. In triangular arbitrage, a trader converts one currency to another, converts that second currency to another, and finally converts the third currency back to the original.

As an example, consider the following. Bitcoin is trading at $4000 USD, euro is trading at $1.1800 and bitcoin is trading against euro at €3380. A trader can sell 1 bitcoin, receives $4000, converts US dollars to 3389.8305 euros and then buys back 1.00290843 BTC on euro bitcoin market for a profit of 0.00290843 per bitcoin.