Arbitrage Strategies and Market Risk

I received a lot of questions on what is the risk of doing arbitrage and how much shall I start with if I want to run the arbitrage trading strategies.

First of all, depend on the trading pair you want to start with. You need capital. As example, if you want to run the arbitrages in altcoin with BTC as pair, you need to have the altcoins first. The arbitrage strategies is suitable to HODL investors or any beginner investor that believe the appreciation of the BTC and altcoins in longer time frame. So, choosing the coins is relatively important.

You may found a lot of market inefficiency among the crypto exchanges around the world. You may need to think more carefully how would you want to start. Let’s take a look at the following scenario: You think the spreads between XXX-BTC pairs has bigger spreads in Exchange A and B.

You decided to start with:

  1. Buy 1.0 BTC, then convert part of 0.5 BTC to XXX coins at price 0.005 You get 100 XXX coins.
  2. Then, you allocate the BTC and XXX coins to Exchange A and B
  3. You start arbitrage process continuously to buy and sell between Exchange A and B whenever spreads exists.

After few months, you may have captured attractive spreads as profit between those activities. But, have you thought about your capital depreciation if you are unlucky? Let’s assume the arbitrage profit within 3 months is 0.15 BTC in total. Your total BTC is as follow:

BTC = 0.50 (your capital) + 0.15 (profit from arbitrage)

XXX = 100 (maintained the same amount as capital)

But unfortunately the price of XXX goes down from 0.005 to 0.0025. It means your total asset when converting back XXX to BTC in total has lost 0.25 BTC in this case. Overall, you have 0.05 less than expected if you just hold BTC in general. That is the market risk you may have to be aware of.

On the other hand, if you are bullish on the XXX and what if you are right? XXX surge from 0.005 to 0.010 in 3 months. It means you are enjoying the capital appreciation at the same time gaining the profit from arbitrage trading.

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