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.
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.
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.
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.