Arbitrage and Price Differentials in DeFi

A beginners guide

May 18, 2023

7 mins.

• Arbitrage is the practice of exploiting price differences across markets to “buy cheap and sell high”. It involves certain risks like exchange liabilities, sudden market movements, regulation risks and more.
• In the context of crypto, there are many types of arbitrage, like cross-platform arbitrage, DEX price arbitrage and many more.  
• Skilled actors use specialized software to profit from these opportunities.
• In Maya, arbitrageurs rebalance liquidity pools in response to the external market forces.

Arbitrage, in general terms, refers to the practice of taking advantage of price differences or discrepancies between two or more markets to make a profit. It involves buying an asset at a lower price in one market and then simultaneously selling it at a higher price in another one. Arbitrage can be found in any market, but is especially relevant in financial markets.

Although the principle of efficient markets states that asset prices should reflect all available information instantly, these are not always perfectly synchronized, and temporary imbalances can occur due to various factors such as conflicting information, crowd psychology, differences in supply and demand, regulatory disparities, etc. For example, in traditional finance, arbitrage often occurs in stock markets, foreign exchange markets, or commodity markets.

Arbitrage in DeFi 

Since arbitrage takes advantage of price discrepancies between different markets and because in the crypto and DeFi context there are hundreds of different markets / platforms, it is only logical that arbitrage opportunities arise constantly and that sophisticated financial actors quickly react to take action on them.

“Arbitrageurs” build custom software, specifically designed and optimized to detect price differentials or discrepancies and execute the necessary trading operations to take them.

Although there are many types of financial arbitrage in DeFi, here are a few common examples:

• Cross-Platform Arbitrage is the easiest arb to spot. If Bitcoin is selling at $30,000 in Binance and trading at $31,000 in Huobi, it’s easy to spot the buying and the selling venue.

• DEX Price Arbitrage works in a similar fashion, however the prices usually have to be derived from the pools’ ratios and more complex considerations have to be made, like gas costs, slippage and MEV bots.

• Perpetual Futures Funding Rate Arbitrage takes advantage of the differences in funding rates between different platforms and different cryptocurrencies. If you take a short position on Bitcoin that receives a rate of 0.05% while taking a long position that charges 0.05% you could have a neutralized exposure to price movements while earning some funding basis points. 

Arbitrage in Maya 

Liquidity Pool Imbalances can happen in Maya depending on the market conditions. When liquidity becomes imbalanced due to changes in supply and demand, an opportunity to rebalance the pool can arise. Arbitrageurs can identify these discrepancies and deposit more assets or CACAO into the pools to make a profit. 

Although arbitrage strategies seem straightforward and are sometimes referred to as being “risk-free”, in practice there are several risks to consider including exchange risks, sudden market movements, regulatory risks, liquidation risks, and highly adversarial competitors. 

Overall, arbitrage and price differentials form an integral part of the DeFi landscape, attracting skilled and specialized actors that end up creating a more efficient and stable market as a result of their trading activities. If you are interested in learning more, make sure to read about arbitrage in our docs and to join our Discord server. You can ask us anything related there and we’ll be happy to help. See you there!