For investors looking for high-frequency transactions with low-risk gains, crypto arbitrage trading is an attractive option.
Arbitrage trading in cryptocurrency is a trading strategy in which investors profit from price fluctuations in a digital asset across several marketplaces or exchanges. Crypto arbitrage trading, in its most basic form, is the process of acquiring a digital asset on one exchange and selling it (nearly) promptly on another at a higher cost.
It involves profit-making with little or no risk. Another advantage of arbitrage trading is that it does not require you to be a professional investor with an expensive setup to begin arbitrage trading. The increasing demand for arbitrage trading has contributed to the need for crypto arbitrage trading bots development.
Why are crypto exchange prices different?
Centralized exchanges
The most important thing to understand about asset pricing on centralized exchanges is that it is decided by the most recent bid-ask matched order on the exchange order book. In other words, the exchange’s real-time price is the current price at which a trader buys or sells a digital asset on the exchange.
Decentralized exchanges
Decentralized cryptocurrency exchanges, on the other hand, price crypto assets differently. This method, known as an “automated market maker,” is entirely reliant on crypto arbitrage traders to keep prices consistent with those shown on other exchanges.
Decentralized exchanges use liquidity pools rather than an order book structure in which buyers and sellers are partnered together to trade crypto assets at a specific price and amount. Each crypto trading pair requires its own pool. If someone wanted to trade Ether (ETH) for the link (LINK), they would need to discover an ETH/LINK liquidity pool on the exchange.
Every pool is backed by volunteers who deposit their own crypto assets to provide liquidity for others to trade against in exchange for a proportionate part of the pool’s transaction fees. The primary benefit of this system is that traders do not need to wait for a counterparty (another trader) to acquire or sell assets at a fixed price. Trading can occur at any time.
A mathematical approach keeps the values of both assets in the pool (A and B) constant throughout the vast majority of popular decentralized exchanges. This method keeps the asset ratio of the pool balanced.
This means that in order to acquire Ether from the ETH/LINK pool, a trader must first contribute LINK tokens to the pool before removing ETH tokens. When this happens, the asset-to-asset ratio shifts (more LINK tokens in the pool and less ETH.) To re-establish equilibrium, the protocol lowers the price of LINK while raising the price of ETH. This encourages traders to withdraw the less expensive LINK and replace it with ETH until prices rebalance with the rest of the market.
