Crypto arbitrage can be highly lucrative for traders and developers who recognize opportunities where one cryptocurrency is undervalued against others on different exchanges.
Trading requires time and resources, from buying an asset on one exchange and then selling it again on another, with transaction fees and transfer times cutting into any profits that might otherwise exist.
Crypto arbitrage traders seek out price differences among decentralized exchanges (DEXs). Unlike centralized exchanges, DEXs don’t offer order book systems where buyers and sellers meet. Instead, DEXs offer liquidity pools for each trading pair that hold specific assets to create its internal balance – when traders swap crypto assets in a DEX, this has an immediate effect on its internal balance and consequently its price.
Liquidity pools’ prices are determined by internal supply and demand conditions between its trading pairs, as well as market capitalization considerations. For instance, if there is more ETH in a liquidity pool than USDC then its pricing would shift accordingly – acting like an ecosystem where goods and services can be exchanged in an interdependent fashion.
Centralized exchanges (CEXs) account for most crypto transactions. These platforms offer security, regulatory compliance, fair pricing and various other features – but their high transaction fees can reduce profits significantly. To alleviate these costs, many traders deposit their crypto assets across various exchanges periodically in order to take advantage of arbitrage opportunities.
Decentralized exchanges (DEXs) have revolutionized arbitrage trading. Most trades on DEXs can be automatically executed via smart contracts, eliminating the need for an intermediary and also remaining non-custodial so users retain full control of both their private keys and cryptocurrency funds.
No matter the benefits of decentralization, traders still must devote significant time and energy to monitoring DEXs for potential trading opportunities; much like centralized exchanges, DEXs may experience liquidity issues and volatility that require their traders to spend extra effort in search and monitoring these exchanges.
To identify arbitrage opportunities, traders must observe multiple markets on different DEXs for every cryptocurrency asset they wish to trade, ensuring each exchange offers its own trading pair for this cryptocurrency asset. When price differences occur between DEXs, traders can capitalize on them by buying or selling the asset at its new price on one exchange and closing their position on another before closing them out to profit from any potential arbitrage opportunities.
traders looking for an easier way to identify arbitrage opportunities may benefit from decentralized liquidity pools like Uniswap, Balancer or Curve. These platforms aggregate various trading pairs from various decentralized exchanges and allow traders to trade digital assets on one single platform. Decentralized exchanges (DEXs) typically feature lower fees and greater liquidity compared to alternative platforms, though it should be remembered that DEX pools relying on individual decentralized exchanges can still be vulnerable to hacks or other risks. dYdX is an Ethereum-based DEX that offers lending and borrowing functionality, margin trading and several advanced features such as Starkware’s Layer 2 scaling solution to reduce blockchain gas fees.