Course Content
What Is Arbitrage Trading?
Arbitrage trading is a relatively low-risk trading strategy that takes advantage of price differences across markets. Most of the time, this involves buying and selling the same asset (like Bitcoin) on different exchanges. Since the price of Bitcoin should, in theory, be equal on Binance and on another exchange, any difference between the two is likely an arbitrage opportunity. This is a very common strategy in the trading world, but it’s mostly been a tool of large financial institutions. With the democratization of financial markets thanks to cryptocurrencies, there might be an opportunity for cryptocurrency traders to take advantage of it, too.
What Is Arbitrage Trading?
About Lesson

There are many types of arbitrage strategies that traders all over the world in many different markets take advantage of. However, when it comes to cryptocurrency traders, there are some distinct types that are quite commonly used.

Exchange arbitrage

The most common type of arbitrage trading is exchange arbitrage, which is when a trader buys the same cryptoasset in one exchange and sells it in another.

The price of cryptocurrencies can change quickly. If you take a look at the order books for the same asset on different exchanges, you’ll find that the prices are almost never exactly the same at exactly the same time. This is where arbitrage traders come in. They try to exploit these small differences for profit. This, in turn, makes the underlying market more efficient since price stays in a relatively contained range on different trading venues. In this sense, market inefficiencies can mean opportunity.

How does this work in practice? Let’s say there’s a price difference for Bitcoin between Binance and another exchange. If an arbitrage trader sees this, they would want to buy Bitcoin on the exchange with the lower price and sell it on the exchange with the higher price. Of course, the timing and execution would be crucial. Bitcoin is a relatively mature market, and exchange arbitrage opportunities tend to have a very small window of opportunity.

Funding rate arbitrage

Another common type of arbitrage trading for crypto derivatives traders is funding rate arbitrage. This is when a trader buys a cryptocurrency and hedges it’s price movement with a futures contract in the same cryptocurrency that has a funding rate lower than the cost of purchasing the cryptocurrency. The cost, in this case, means any fees that the position may incur.

Let’s say you own some Ethereum. Now you might be happy with that investment, but the price of Ethereum is going to fluctuate a lot. So you decide to hedge your price exposure by selling a futures contract (shorting) for the same value as your Ethereum investment. Let’s say the funding rate for that contract pays you 2%. That would mean you’d get 2% for owning Ethereum without any price risk, resulting in a profitable arbitrage opportunity.

Triangular arbitrage

Another very common type of arbitrage trading in the cryptocurrency world is triangular arbitrage. This type of arbitrage is when a trader notices a price discrepancy between three different cryptocurrencies and exchanges them for one another in a kind of loop.

The idea behind triangular arbitrage comes from trying to take advantage of a cross-currency price difference (like BTC/ETH). For example, you could buy Bitcoin with your BNB, then buy Ethereum with your Bitcoin, and finally buy back BNB with Ethereum. If the relative value between Ethereum and Bitcoin doesn’t match the value each of those currencies has with BNB, an arbitrage opportunity exists.