In the financial markets, arbitrage trading refers to simultaneously buying and selling an asset or a security on two different exchanges to generate a profit from the price differential found on set two exchanges.
For example, if the price of a security asset is trading at USD 100 on exchange A and USD 99 on exchange B, a trader can buy the asset for USD 99 on exchange B and sell it for USD 100 on exchange A at the same time to generate a largely risk-free profit of USD 1. That is how arbitrage trading works.
These arbitrage opportunities found on different exchanges are actually what keep the market relatively efficient. In other words, it ensures that prices are roughly the same across different exchanges for the same asset because if that is not the case arbitrage traders will come in and capitalize on this profit opportunity immediately.
In the stock markets, arbitrage trading is usually conducted through high-frequency trading software that seeks out arbitrage opportunities and automatically executes trades on behalf of the investor. Hedge funds and proprietary trading companies are the most common users of these algorithmic trading strategies in the stock market.
As price differential for cryptocurrencies can be quite large across exchanges, there is ample opportunity to make arbitrage trading profits in the digital asset space. Even the most liquid crypto asset bitcoin trades at different price levels on different exchanges.
Just take a look at the Price Tracker on Cryptonews.com:
The widest differential can be found between geographical regions. On Zimbabwe’s leading digital currency exchange Golix, for example, bitcoin traded at a 30 to 40% premium to the international market price last year. That was because there was more demand for bitcoin in Zimbabwe due to its dire economic situation but fewer options to purchase the digital currency than in other countries. Hence, the price traded higher in the Southern African nation.
Substantial price differentials can also often be witnessed when comparing Korean exchanges and U.S. exchanges. For example, during the peak of 2017, the regularly higher prices for cryptocurrencies in South Korea driven by strong local demand have led traders to dub this price differential the “kimchi premium”.
Having said that, cryptocurrency price differentials also exist on exchanges based in the same jurisdiction and these can be more easily exploited than trading across borders as there is no added currency risk when cashing out into fiat currency.
Cryptocurrency prices vary across exchanges due to differences in liquidity, a lack of international price referencing standards, and the inefficiency of making fund transfers between exchanges.
Moreover, prices on some exchanges, e.g. Bitfinex, might be higher due to fact that it’s expensive to withdraw fiat from an exchange and this increases demand for cryptocurrency as this is a much cheaper way to move your funds from the exchange.
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We are committed to providing alternative investment solutions to clients, and our capabilities in the hedge fund space are broad, as we present the return potential and diversification at the total portfolio level.
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