Written by Evan Francis, CEO & co-founder of Coygo Inc. which provides tooling for professional cryptocurrency trading and insights. A cryptocurrency advocate since 2010, Evan has years of experience working as a software engineer in fintech before leaving his corporate job to pursue a full-time venture in the cryptocurrency and digital asset space.
Most traders have heard of triangular arbitrage at one time or another, but do you really understand how it works and how you can use it as a tool in your trading toolbelt?
In this guide we’ll explain what cryptocurrency triangular arbitrage is and how you can identify opportunities yourself. With the right tools and determination anyone can be an arbitrageur!
What is triangular arbitrage?
Triangular arbitrage is a trading technique that aims to profit off of a price discrepancy between three different assets on the same exchange. This is something that’s been done for years in the forex markets and it can be applied to cryptocurrency markets as well.
For example you could start with a balance in USD, buy BTC with that USD on a BTC-USD market, then buy LTC with that BTC on a LTC-BTC market, then finally sell that LTC for USD on a LTC-USD market. If the Bitcoin and Litecoin prices are aligned in your favor you will start and end with USD and gain some amount of USD in the process.
Why would someone want to try triangular arbitrage?
Arbitrage that can be performed immediately can theoretically offer a low-risk opportunity for profit. This is because when it’s done right you’ll submit accompanying orders at the same time and immediately realize a profit (or loss) without having to wait on timing the market to try and make a profit by selling at the right moment.
Triangular intra-exchange arbitrage in particular is appealing because it happens entirely on one exchange, unlike other inter-exchange arbitrage strategies that involve trading across multiple exchanges.
Of course there are risks associated with arbitrage, particularly because you’re competing with other traders (and trading bots) who are trying to race to act on an opportunity before others do. In general trading bots are very competitive and you’ll want to use some sort of tooling that is capable of assisting with real-time analysis and submitting orders if you want to gain an edge over the competition.
How do I identify a triangular arbitrage opportunity?
To find opportunities that are profitable we can do some math to determine if a cross-rate is overvalued, meaning that there is a price discrepancy when trading between three different assets that would result in a profit if our orders are performed correctly. Heads up, we’re going to dive deep into the numbers here!
Orders can occur on two different order paths, both resulting in starting and ending with the same asset (USD in this example). We’ll cover each separately since the math for each is a…