Arbitrage

The textbook example

The same stock might trade at $100.05 on the NYSE and $100.00 on a foreign exchange a few seconds later. An arbitrageur buys on the cheaper exchange, sells on the more expensive one, pockets the spread. Repeat at scale.

In practice, opportunities like this rarely exist long enough for a human to act on — high-frequency trading firms compete to close them in microseconds, and successful arbitrage usually requires meaningful technology investment. The pure version is a mathematical idealization; real-world arbitrage involves execution risk, transaction costs, and timing.

Types of arbitrage

• Spatial arbitrage — same asset, different venues (the textbook example).
• Triangular arbitrage — three currency pairs whose cross-rates don't quite line up. Buy USD/EUR, EUR/JPY, JPY/USD in sequence and end with more dollars than you started.
• Statistical arbitrage — pairs of historically correlated assets (e.g., two oil companies) drift apart, bet they'll converge.
• Merger arbitrage — when company A announces it's buying company B at $50/share, B's stock typically trades just below $50. The arb bets the deal closes at the announced price, taking the small spread as compensation for the risk that it doesn't.
• Convertible arbitrage — exploit pricing differences between a convertible bond and the underlying stock.
• Cash-and-carry — buy spot, sell futures, lock in the difference (works whenever futures trade above spot, called contango).

In crypto

Arbitrage is constant in crypto markets and disproportionately important. Different exchanges price the same asset differently because the market is fragmented across hundreds of venues with imperfect connectivity. DEX-vs-CEX, DEX-vs-DEX, and chain-vs-chain spreads exist nearly all the time.

The on-chain version is also a major source of MEV: bots monitoring the Ethereum mempool and the order books of various DEXes will execute multi-hop arbitrage trades within a single transaction, often using flash loans to fund the position with no upfront capital. When the trade is profitable, they repay the loan and pocket the difference; when it isn't, the transaction reverts and they lose only the gas cost.

Why arbitrage is economically important

Arbitrage is the mechanism through which prices in one market influence prices in another. Without arbitrageurs, the same asset could trade at wildly different prices in different venues indefinitely. Their activity — even when criticized as parasitic — is what keeps markets connected and prices coherent.

In efficient markets, persistent arbitrage opportunities shouldn't exist. The fact that they keep appearing is itself useful information: it indicates a market segment that's still maturing, or specific structural reasons (regulatory frictions, capital constraints, settlement delays) that prevent normal price convergence.