Arbitrage Trading in the Cryptocurrency Market

Follow us on LinkedIn

Cryptocurrency is a digital or virtual asset that uses cryptography to secure its transactions. Cryptocurrencies are decentralized, meaning they are not subject to government or financial institution control. Bitcoin, the first and most well-known cryptocurrency, was created in 2009. Cryptocurrencies are often traded on decentralized exchanges and can also be used to purchase goods and services.

There are four main strategies for trading cryptocurrencies:

  • Mean reversion
  • Momentum trading
  • Trend following
  • Arbitrage trading

The first 3 trading strategies are based mostly on time-series and cross-section price prediction. Relatively little attention is paid to the last one, i.e. arbitrage trading strategy.

Arbitrage trading takes advantage of price differences in different markets.  Here’s an overly simplistic example: if Bitcoin is selling for $11,000 on one exchange and $11,100 on another, a trader can buy Bitcoin on the first exchange and immediately sell it on the second exchange for a $100 profit. In order to be successful, an arbitrage trader must have access to capital, be able to move capital quickly, and have a low overhead.

Reference [1] examined some common and unique arbitrage trading opportunities in cryptocurrency exchanges that are not discussed often in the literature. They are,

  • Exchange futures contract funding rate arbitrage
  • Exchange futures contract intertemporal arbitrage
  • Triangular arbitrage
  • Pairs trading
  • Order book spread prediction arbitrage

The author found that,

Many pieces of research are done on cryptocurrency time-series and cross-section price prediction. This paper examines some common and unique arbitrage opportunities in cryptocurrency exchanges that are not widely mentioned in academic journals. It is shown that these semi-risk free arbitrage can provide a great return with minimal risk, despite constraints of actual market conditions and exchanges conditions that make them perform worse in live trading than backtesting. By mixing these strategies into portfolios, we could achieve a higher Sharpe ratio than simply holding cryptos.

In short, arbitrage trading is possible and profitable in the crypto market.

Our observations are as follows,

  • These trading strategies are not riskless. Drawdown can happen
  • Diversification helps smooth out the equity curves greatly

Last and not least, since the crypto market is still in its early days, we don’t know whether other risks such as liquidity, counterparty credit risk, etc. were factored in the price discrepancies.

Let us know what you think in the comments below.

References

[1] Tianyu Zhou, Semi Risk-free Arbitrages with Cryptocurrency, 2022 5th International Conference on Financial Management, Education and Social Science (FMESS 2022)

Further questions

What's your question? Ask it in the discussion forum

Have an answer to the questions below? Post it here or in the forum

LATEST NEWSHigh stakes and glitz mark the vote in Paris for the 2030 World Expo host
High stakes and glitz mark the vote in Paris for the 2030 World Expo host

PARIS (AP) — In a high-profile showdown, Rome, Busan, and Riyadh are the top contenders as the Bureau International des Expositions (BIE) prepares to vote on Tuesday in Paris for the host city of the 2030 World Expo. With the stakes high, each city has…

Stay up-to-date with the latest news - click here
LATEST NEWSRockefeller Foundation Makes Net Zero Pledge for $6 Billion Endowment
Rockefeller Foundation Makes Net Zero Pledge for $6 Billion Endowment

It’s the largest private foundation in the US to make the commitment, with a target date of 2050.

Stay up-to-date with the latest news - click here
LATEST NEWSThe best Cyber Monday NAS hard drive deals in 2023
The best Cyber Monday NAS hard drive deals in 2023

There's still time to save on tech like network-attached storage during Cyber Monday 2023, with discounts on drives from Western Digital and Toshiba.

Stay up-to-date with the latest news - click here
LATEST NEWSHere’s what happened in crypto today
Here’s what happened in crypto today
Stay up-to-date with the latest news - click here
LATEST NEWSPlenti shares surge on strategic alliance with National Australia Bank
Plenti shares surge on strategic alliance with National Australia Bank
Stay up-to-date with the latest news - click here

Leave a Reply