Arbitrage – What is it and how to profit from it?
In economics and finance, arbitrage (US /ˈɑrbɨtrɑːʒ/, UK /ˈɑrbɨtrɪdʒ/, UK /ˌɑrbɨtrˈɑːʒ/) is the practice of taking advantage of a price difference between two or more markets: striking a combination of matching deals that capitalize upon the imbalance, the profit being the difference between the market prices.
Basically arbitrage is taking advantage of the difference in price of the same or similar financial instruments – for example buying assets on different markets and then selling them elsewhere with a better price. It’s not essential for the price to change, you are essentially profiting only from the differences in price by different providers. Different brokers and platforms are doing their best to keep the prices the same however because there’s so many of them that is simply not always possible.
Profits from arbitrage will be considerably smaller than from the price making a huge jump your way as with arbitrage the differences are generally minute. However when doing a lot of these transactions with large amounts you will be able to gain quite considerable amounts without having to predict or have a wider knowledge of the markets. Also the benefits of arbitrage are that as you are not speculating on the price but cashing out immediately with the agreed price it is essentially risk free and the profits are instant.
Let’s give you an example of how it works:
If you were quick you may have been able to take advantage of this on our platform:
At the end of August you would’ve had the opportunity to exploit the price differences on Poloniex and our platform. On the 23rd, 24th and 25th of August the price of ETH/BTC on Poloniex was
0,0066 and 0,0072 on HitBTC – perfect conditions for arbitrage. If you sold 200 BTC on Poloniex for ETH price 0,0063 you would’ve got ~30303 ETH
Then sell them on HitBTC for the price of 0,0072. 30303 ETH * 0,0072 = 218,18 BTC
The profit is 218,18 – 200 = 18.18 BTC or ~$2700! Quick and risk free profits with arbitrage!
This is why it’s good to keep an eye out on the goings on of different platforms.
When can I use arbitrage?
Arbitrage can occur when at least one of the following conditions are met:
- The same asset ( currency, index, asset, stock etc.) is not currently at the same price on all markets.
- Two assets or instruments with similar or same cash flows trade at different prices.
- An asset with a fixed price in the future is trading at a lower or discounted interest free rate due to some current conditions.
Hence arbitrage is not similar to trading as you’re not looking to buy an asset and then sell it at a later time for a higher value. Your transactions need to occur immediately to avoid risk and change in price and only profiting from the differences this is why speed is key here. You must act fast enough to be able to profit just from discrepancies in the markets without incurring a loss due to changes in price.
Is it worth it?
With any kind of trading there are risks involved however “Real” arbitrage is only arbitrage when there is no risk involved. If you find substantial differences on different markets, platforms or providers and have the opportunity to invest fast enough and cash out instantly or simply changing it to another asset then it is a simple way to make profits without having the price turn against you. This is the difference between arbitrage and traditional trading, there is simply no speculation involved, just finding the right opportunities and acting fast. Of course there are risks like for example financial crisis that even with arbitrage can lead to bankruptcy however luckily they do not occur often and they are usually not instant.