Arbitrage is a financial strategy that exploits price differences for the same asset in various markets. The objective of arbitrage is to purchase an asset at a lower price in one market and simultaneously sell it at a higher price in another, thereby generating a profit with minimal risk.
Arbitrage opportunities arise due to market inefficiencies, imbalances in supply and demand, or differing pricing mechanisms on various trading platforms. Arbitrageurs carefully monitor these fluctuations and often execute transactions automatically to capitalize on price differentials. For instance, a trader may buy Bitcoin on the Binance cryptocurrency exchange at a slightly lower price than on Coinbase and then sell it on Coinbase to capture the deviation.
Impact of arbitrage on the crypto markets
Arbitrage not only helps maintain relatively consistent prices for identical assets across different trading platforms but also contributes to market efficiency by swiftly correcting any disparities. In particular, in the world of cryptocurrencies, which can be illiquid and fragmented across multiple platforms, exchanges rely on arbitrageurs to ensure smoother market operations.
However, the speed and automation of modern trading have made arbitrage opportunities rarer and more fleeting. Today, traders often require sophisticated strategies to successfully profit from market inefficiencies. In the crypto world, these arbitrage opportunities are sometimes referred to as Maximum Extractable Value (MEV).