Arbitrage is defined as the practice of taking advantage of a price difference between two or more markets.
In particular, this involves the simultaneous buying and selling of securities, currencies, cryptos, or commodities in different markets.
Arbitrage has the effect of causing prices of the same or very similar assets in different markets to converge over time.
In order for arbitrage to occur, there must be a uniform set of conditions that need to be met.
For example, the same asset does not trade at the same price on all markets, two assets with identical cash flows do not trade at the same price, and an asset with a known price in the future does not today trade at its future price discounted at the risk-free interest rate.
Arbitrage in Cryptocurrency Markets
In the cryptocurrency space, arbitrage refers exclusively to the practice of buying a crypto coin for one price on an exchange and then simultaneously selling it at a higher price on another.
The profit that is earned from these temporary price differences is considered to be a risk-free venture for the investor.
Arbitrage is especially prevalent on crypto exchanges given the price differences that exist. It is common for differences in crypto prices to vary by the region or where a crypto exchange is based from.
For example, high Bitcoin trading volumes and accordingly high Bitcoin prices on South Korean crypto exchanges resulted in what became known as the “Kim-chi premium.”
Traders who had access to exchanges in South Korea and exchanges elsewhere in the world where the price of Bitcoin was lower had the opportunity to earn arbitrage.
This involved buying BTC on exchanges with lower prices and them selling them on South Korean exchanges where prices were inflated.
Crypto exchanges are evolving however to control for arbitrage though opportunities for this practice are still occurring.