What is Arbitrage? 

A lot of people have been paying attention to Sam Bankman-Fried (SBF) lately…not just because he runs the FTX Exchange, but also because he became a self-made Billionaire by age 29 through crypto arbitrage trades. 

Arbitrage is an investment strategy in which an investor simultaneously buys and sells an asset in different markets to take advantage of price differences, with the goal being to generate a profit. While price differences are typically small and short-lived, the returns can be impressive when multiplied by a large volume. Arbitrage is commonly leveraged by hedge funds and other sophisticated investors that have access to very fast connections and massive amounts of computing power. 

As a quick example of pure arbitrage, let’s say that you found a sale on Titleist Pro V1 Golf balls at your local WalMart; they are priced at $20 for a dozen balls. You know that they are currently selling for $49.95/dozen on Amazon, so you accumulate as much cash as you can and buy out all of the Titleist golf balls at WalMart, and list them on Amazon that night for $48.95/dozen. You immediately sell out your inventory and profit a tidy $28.95/dozen for conducting an arbitrage trade. You were limited by capital and probably supply as well, otherwise you could have done this arbitrage trade forever. 

This is the nature of Arbitrage; once you start to exploit the pricing difference for one asset in two different locations, then it’s only a matter of time before the difference is noticed and neutralized. 

Arbitrage in Crypto

SBF exploited an arbitrage called the Kimchi Premium; While Bitcoin was pricing at around $10,000 in the US, it traded for $15,000 on Korean exchanges. This was because of a huge demand for Bitcoin in Korea, according to SBF. Around its peak, there was a vast spread of around 50%. He would buy inventory in the US for $10,000 and then sell it for $15,000 on Korean exchanges. While it sounds easy in theory, the difficulty was in converting the Korean currency back into dollars, so there is some currency risk to the trade. 

Through this week, I’ll discuss some Arbitrage solutions that are still possible in the crypto space.