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Playing the Liquidity Game: Opportunity to Arbitrage Across Multiple Exchanges for Greater Returns

December 17, 2020
The extreme volatility of the cryptocurrency markets has long caught the attention of the traditional financial space. However, what started out as outright dismissal has gradually led to increased participation and now, some may argue, institutional traders are leading the charge. As the regulatory framework has become clearer and the infrastructure more resilient and robust, institutional crypto trading has taken off in earnest.

The electrifying pace of the markets and their rapid price action allows for a wide range of trading strategies and arbitrage opportunities that no longer exist in traditional financial markets. Taking advantage of the difference in Bitcoin prices from one exchange to the next and exploiting the young market's multiple inefficiencies allows traders to play the liquidity game and arbitrage across multiple exchanges for greater returns.


Explosive YTD Returns on Digital Assets 


2020 has certainly been an atypical year in the investment field. Yet with all asset classes facing the same extraordinary macro factors, cryptocurrency has fared remarkably better than both traditional haven assets like gold and also riskier assets such as equities. Despite the sharp selloffs and flight to cash at the height of the pandemic in March, investors' appetite for riskier assets appears to have been rekindled.


Take the S&P 500 for example. That has delivered investors a YTD return of 13%. The Nasdaq has fared significantly better, yielding a return of 38%. And, if we single out one of the most popular tech stocks, Amazon (AMZN), that's brought in an impressive YTD of 72%. 


Gold has certainly been a preferable investment to the U.S. dollar, posting YTD gains of around 20% while the dollar continues to slide, registering YTD losses of almost 6%. Since its brief rally at the start of the year, multi-trillion-dollar stimulus packages and unchecked QE have caused traditional macro investors and hedge fund managers like Paul Tudor Jones and Stanley Druckenmiller to add Bitcoin (BTC) to their portfolios. Publicly traded companies like MicroStrategy and Square also have 'skin in the game,' adding BTC to their balance sheets. 

It has not disappointed. BTC has rebounded from its "pandemic low" by more than 400%, posting a YTD gain for investors of 170%. Other digital assets have also turned investors' heads with staggering performances this year. The ethereum price, for example, is even more arresting in terms of percentage gains, with a YTD increase of 375%. 


Taking Advantage of Cryptocurrency Volatility and Arbitrage


With all this impressive action, while fiat currencies struggle and stocks look lackluster by comparison, it's no wonder that institutional digital asset trading has become the norm. With the chance of making fortunes for clients from the volatility of bitcoin trading, hedge fund managers, investment bankers, private equity investors, mutual funds, and more, are a rapidly growing percentage of the cryptocurrency space.


Grayscale Bitcoin Trust, for example, now custodies more than 500,000 Bitcoin for its institutional clients, worth more than $10 billion in value. BTC inflows into Grayscale are still accelerating, equivalent to around 77% of the total bitcoin mined during Q3, 2020. 


However, while these high-risk alternative assets capture the imagination of institutional investors, not everyone is open to such gut-wrenching volatility. Investors that are more risk-averse are still making greater gains on their cryptocurrency investments by taking advantage of the abundant arbitrage opportunities available.


Arbitrage is even more appealing (and frequent) in digital assets and Bitcoin trading. Since arbitrage takes advantage of inefficiencies in the market, highly volatile assets like cryptocurrency with its massive price fluctuations lead to multiple differences in price across exchanges. This allows traders to simultaneously buy a crypto asset low and sell the same asset higher to make a net profit. 


Simple Arbitrage in Crypto Trading


Arbitrage opportunities in cryptocurrency arise in the same way as any other market, and it is first necessary to identify the overlap between the highest bid prices and the lowest ask prices. For example, once a trader identifies that the Ethereum (ETH) bid price is higher on one digital asset exchange than the ask price on another, the opportunity for simple arbitrage is evident.


Since arbitrage opportunities often last for seconds only, time is of the essence, yet it's also vital to assess the value of the opportunity before acting. Keep in mind that executing the arbitrage will lead to consuming the order book and thereby reducing the arbitrage size after the price value is taken. This means that you might not be able to take advantage of the entire arbitrage opportunity, and maybe only a fraction of the value. So it's worth simulating the exchange of actual buys and sells to see how much profit can actually be realized on the arbitrage.


Simple arbitrage, in which traders buy and sell the same cryptocurrency on different trading platforms as quickly as possible, can help traders maximize gains with minimal risk and take advantage of the inefficiencies of pricing across crypto exchanges. As the name implies, the beauty of this strategy lies in its simplicity, as no additional trades are required outside those necessary to exchange the two assets. Yet, cryptocurrency markets also lend themselves very well to triangular arbitrage.    


Triangular Arbitrage Opportunities


Digital asset trading presents investors with even more opportunities for greater returns through triangular arbitrage which can occur on just one crypto asset exchange or over multiple platforms. Since most large exchanges offer multiple markets with a variety of quote currency options, price differences often occur between three cryptocurrencies, opening up abundant opportunities for triangular trading. 


Let's say, for example, that there are three different digital asset pairs on a single trading platform: XRP/BTC, XRP/ETH, and ETH/BTC. Traders can follow a triangular trading pattern to profit from the exchange's price inefficiencies. 


Starting with one crypto asset (to which they will eventually return after completing the arbitrage loop), investors can trade to the second cryptocurrency, connecting the original asset to the next asset in the loop. When they trade to the third currency connecting both the first and second asset, this second trade locks in a zero-risk profit due to the rate inconsistencies across the three pairs upon converting back to the original asset. 


The Best Way to Take Advantage of Arbitrage


By exploiting arbitrage opportunities, traders can greatly increase their Bitcoin value (and that of other crypto assets as well). These can occur on just one exchange or over multiple exchanges, so to carry out arbitrage successfully, you'll need to place funds on at least two different exchanges, and ideally on several exchanges to capitalize on more opportunities.


Of course, the downside of any type of arbitrage is that it takes time to identify the opportunities and execute them fast enough to take full advantage. Fortunately, you no longer need to put in the time-intensive legwork or dedicate the resources to build the infrastructure you need to implement a successful arbitrage strategy. 


Using an institutional-grade digital asset trading tool that's built on top of existing platforms can provide digital asset traders with the ability to seamlessly and rapidly execute arbitrage from various exchanges - all from within one multi-asset class integrated solution like Access from Diginex.


Access is exchange agnostic and aggregates real-time full-depth market data from all major spot and derivatives trading platforms, allowing you to play the liquidity game and increase your crypto trading offer. 


It provides a unified execution management system that allows investors to manage their trading activities more efficiently through a suite of innovative algos, ensuring the best execution of a number of trading strategies and arbitrage opportunities. Ready to find out more? Request a demo.

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