Introduction to Arbitrage

Essence of Arbitrage

Arbitrage in crypto involves capturing profits from price discrepancies of the same asset across different platforms. This occurs when an asset is priced differently on various venues, allowing traders to buy low on one venue and sell high on another.

Basic Flow of Arbitrage:

1. Price Discrepancy. In the highly dynamic crypto landscape, multiple operations occur every second across different venues, creating price discrepancies for the same asset.

2. Arbitrage Opportunity Identification. Traders identify opportunities by monitoring multiple exchanges and tracking asset prices using tools, algorithms, or automated arbitrage software to quickly spot these discrepancies.

3. Opportunity Analysis. Traders analyze whether executing the arbitrage is profitable, considering factors such as gas costs, transaction fees, bridge fees, and other expenses, as well as associated risks such as frontrunning by MEV-bots, fee-based forking attacks, time-bandit attacks, and others.

4. Execution & Profit. If the analysis deems the arbitrage profitable, the trader executes the arbitrage quickly capitalizing on the price difference before it disappears.

Suppose ETH is priced at $3,000 on Exchange A and $3,010 on Exchange B. A trader buys 10 ETH on Exchange A for $3,000 each and sells them on Exchange B for $3,010 each. Liquidity is deep enough in both pools for slippage to not occur. The gross profit is $100. After accounting for $3 in gas fees and $1 in transaction fees, the net profit is $96.

Basic Arbitrage Math

Basic arbitrage formula looks as follows:

$$Profit = Opportunity - Expenses$$

Where:

$$Profit > Opportunity - Expenses$$

And, therefore:

$$Opportunity > Expenses$$

Opportunity is a price discrepancy between Asset A on different venues, therefore:

$$Opportunity = Price of Asset X on Venue A - Price of Asset X on Venue B$$

Where:

$$Price of Asset X on Venue A > Price of Asset X on Venue B$$

To calculate Profit we should define and further exclude expenses out of our opportunity:

$$Expenses = Transactional Costs + Infrastructure Costs + Other Expenses$$

$$Transactional Costs = Gas Fees + Transaction Fees + Bridging Fees$$

$$Expenses = Gas Fees + Transaction Fees + Bridging Fees + Infrastructure Costs + Other Expenses*$$

* Other Costs might include fees charged by CEX exchanges for withdrawing or depositing assets, or flashloan fees and/or other currently unpredictable expenses.

It is also notable that we have excluded slippage (the difference between the expected price of a trade and the actual execution price due to market movements during the trade process) for the following reasons: (i) for the purpose of this paragraph, it is not of primary importance; (ii) slippage can affect a trade in both positive and negative ways, though it rarely makes trades more profitable; (iii) our algorithm accounts for slippage in its calculations.

Expanded formula looks as follows:

$$Profit = (Price of Asset X on Venue A - Price of Asset X on Venue B) - (Gas Fees + Transaction Fees + Bridging Fees + Infrastructure Costs + Other Expenses)$$

Example:

The user spots an arbitrage opportunity involving Ethereum (ETH) on two exchanges on 2 different networks. The user notices that the price of ETH on Exchange A on ERC-20 is $3,050, while on Exchange B on BSC, it's $3,000, revealing a $50 price discrepancy.

Opportunity = $3050 - $3000 = $50

Planning the trade, User decides to buy 1 ETH on Exchange B for $3,000 and sell it on Exchange A for $3,050.

The user calculates the costs involved: $3 in gas fees, $1 in transaction fees, and $3 for bridging from BSC to ERC-20, totaling $7. There are no infrastructure costs since the user performs the arbitrage manually, and there are no other expenses involved.

Expenses = Transactional Fees ($7) + Infrastructure Costs ($0) + Other Expenses ($0)

Confident in the plan, User buys 1 ETH on Exchange B on BSC for $3,000, transfers it to Exchange A on ERC-20, and sells it for $3,050.

The profit calculation is as follows:

Profit = ($3,050−$3,000) − $7 = $43.

Despite the initial $50 opportunity, the various costs reduce the final earnings to $43. This example demonstrates how User effectively capitalizes on the price discrepancy, ensuring a profitable trade after accounting for all expenses.

What kind of arbitrage does Arbix search for?

Arbix employs a variety of arbitrage types to maximize profitability and efficiency. The following sections detail the primary and additional arbitrage types that are or may be integrated into Arbix, each designed to explore different market conditions and opportunities.

Despite there are a lot of different types of arbitrage existing in nature, Arbix is going to primary use following types/strategies:

• Simple On-Chain Arbitrage:

  • Description: This straightforward form of arbitrage involves buying an asset at a lower price on one platform and selling it at a higher price on another.

  • Example: Purchasing ETH on Exchange A where it is priced lower and selling it on Exchange B where the price is higher on the same network;

  • Arbix Use Case: Arbix performs simple on-chain arbitrage by buying assets with one pool and selling them at a higher price so that the assets end up back in the same source pool.

• Cross-Chain Arbitrage:

  • Description: This arbitrage strategy takes advantage of price differences of the same asset across different blockchain networks.

  • Example: Buying a token on ERC-20 where it's cheaper and selling it on BSC where it's more expensive.

  • Arbix Use Case: Arbix executes cross-chain arbitrage by buying an asset on one network where it is cheaper and selling it on another network, utilizing parallel execution via multi-chain liquidity pools.

• Triangular Arbitrage:

  • Description: This type of arbitrage involves trading between three different assets to take advantage of price differences among them.

  • Example: Trading USDT for ETH, ETH for WBTC, and WBTC back to USDT among different liquidity pools and/or chains, profiting from the discrepancies in exchange rates.

  • Arbix Use Case: Arbix performs triangular arbitrage by identifying and executing trades across multiple asset pairs on various exchanges using its liquidity pools. The algorithm detects profitable cycles and executes them efficiently.

• CEX-DEX Arbitrage:

  • Description: take advantage of the price differences of the same asset on different exchanges, which can be within the same asset class.

  • Example: Buying a cryptocurrency at a lower price on a decentralized exchange (DEX) and selling it at a higher price on a centralized exchange (CEX).

  • Arbix Use Case: Arbix takes advantage of CEX-DEX arbitrage by monitoring price discrepancies between centralized and decentralized exchanges, executing trades to capture the price differences and generate profits.

Additional Factors in Arbitrage Opportunity Analysis

It is important to mention what can also affect successful arbitrage. Major factors affecting arbitrage profit and volumes can be split into three categories: financial and market, expenses, and technological.

Financial & Market:

• Slippage. Refers to the difference between the expected price of a trade and the actual price at which it is executed. High slippage can erode profits or even turn a profitable trade into a loss.

• Liquidity. Adequate liquidity is essential to execute large trades without significantly affecting the asset’s price. Low liquidity can lead to higher slippage and less profitable trades.

• Volatility. High volatility increases the likelihood of price discrepancies between exchanges, directly affecting the number of arbitrage opportunities.

Expenses:

• Transaction Costs. Costs such as gas fees, trading fees, and bridging fees can erode arbitrage profits. High costs can make certain arbitrage opportunities unprofitable.

• Infrastructure Fees. Expenses related to maintaining and operating the necessary technological and logistical infrastructure, such as server costs, API access fees, and software subscriptions.

• Other Expenses. Additional costs might include fees charged by CEX exchanges for withdrawing or depositing assets, flash loan fees, and other currently unpredictable expenses.

Technological:

• Transaction Speed. The speed at which transactions are confirmed can significantly impact arbitrage success. Delays can result in missed opportunities as price discrepancies may vanish before trades are executed.

• Technological Infrastructure. The robustness and efficiency of the technological infrastructure play a crucial role in successful arbitrage. Superior technology enables faster detection and execution of arbitrage opportunities.

Arbix takes all these factors into account when designing its arbitrage strategies and optimizing its algorithm. Other factors, such as regulatory compliance (for example, ensuring adherence to applicable laws and agreements while performing DEX/CEX arbitrage within the CEX regulatory field), security measures, and market manipulation, are also taken into account.