What is arbitrage: a complete guide to trading strategies in the cryptocurrency market

Arbitrage is an investment strategy that exploits price differences of the same asset across different trading platforms or market segments. The concept is simple: a trader simultaneously buys the asset where it is cheaper and sells where it is more expensive, earning a profit from the price difference with minimal market risk.

In the cryptocurrency market, arbitrage has become especially popular due to high volatility and the diversity of trading instruments. The main types of arbitrage include spot operations (physical assets), funding rate-based strategies, and trading with futures contracts.

Arbitrage as an Investment Strategy: Main Types

There are several primary approaches to arbitrage trading in the cryptocurrency market.

Spot Arbitrage involves simultaneously buying cryptocurrency on one exchange and selling it on another. This is the most traditional form of arbitrage, where traders capitalize on temporary price differences between different platforms. For example, if Bitcoin costs $60,000 on one exchange and $60,500 on another, a trader can buy at the lower price and sell at the higher, locking in a profit.

Funding Rate Arbitrage is a more complex strategy that involves both the spot market and the perpetual contract market. The essence is that perpetual contracts have a funding mechanism where traders with long positions pay fees to traders with short positions (or vice versa). When this rate is positive and high, a trader can buy the asset on the spot and simultaneously open a short position in the perpetual contract, earning income not only from hedging but also from funding fees.

Price Spread Arbitrage involves trading the difference between the spot price and the futures contract price. At contract expiry, the futures price should converge with the spot price. If the spread between them is abnormally large, a trader can open opposite positions and profit from the convergence of prices.

How Arbitrage Works in Financial Markets

To successfully apply arbitrage, it’s important to understand how it functions in practice.

Positive Funding Rate Arbitrage occurs when the funding rate on perpetual contracts is positive. This means long position holders pay short position holders. In this scenario, an arbitrage trader can:

• Buy the asset on the spot market
• Simultaneously open a short position in the perpetual contract of the same size
• Hold both positions to receive regular funding payments
• Close both positions when the funding rate decreases or when the targeted profit is reached

Negative Arbitrage works in the opposite way. When the funding rate is negative, short positions pay long positions. In this case, a trader can open a short position on the spot (if possible) and a long position in the perpetual contract, earning profits from funding payments.

Hedging via Arbitrage allows neutralizing price risk. Suppose a trader already owns one Bitcoin on the spot market. If the spread between the spot price and the futures price is significant, they can sell a futures contract of the same volume. Price fluctuations on the spot will be offset by opposite movements in the futures market, and the trader will profit from the price difference when closing the position.

Methods for Calculating Profitability and Risk Management in Arbitrage

Understanding how to calculate potential profit is critical for making informed decisions about opening positions.

Basic Spread Formula:

• Spread = Selling price of the asset − Buying price of the asset
• Spread percentage = (Selling price − Buying price) / Selling price × 100%

Annual Percentage Rate (APR) Calculation for Funding Rates:

• APR = (Total funding rate over 3 days / 3) × (365 / 2)

The factor 2 in the denominator accounts for the fact that, on average, only half of the capital is at risk (one component of hedging).

APR Calculation for Spreads:

• Spread APR = (Current spread size / Maximum days until expiry) × (365 / 2)

These calculations help compare different arbitrage opportunities and select the most profitable ones.

Main Risks of Arbitrage:

Although arbitrage is considered a low-risk strategy, it is not without dangers. The primary risk is liquidation of the position, which occurs if orders are not executed properly. If the buy order on the spot market is fully filled but the sell order in the futures market is only partially filled, the trader ends up with an open position in a direction that was not fully hedged. Market fluctuations can then lead to losses.

Additional risks include:

• Slippage — during rapid market movements, the actual execution price may differ from the expected price
• Insufficient liquidity — in low-liquidity pairs, it’s harder to quickly open or close positions
• Trading fees — accumulated fees for orders and funding can erode profits
• Technical delays — lag in synchronization between markets can give traders an opportunity to close the spread at unfavorable prices

Practical Tips for Applying Arbitrage Strategies

For those who decide to implement arbitrage in practice, here are some key recommendations.

Timing Entry: Arbitrage opportunities appear at specific times. It’s best to look for spreads during high volatility, after sharp price jumps, or during major news releases. During calm market periods, spreads are often too small to cover fees.

Handling Large Orders: When placing large volumes on the spot market, traders often use limit orders to minimize slippage. Combining orders on opposite markets helps distribute the impact of large trades and reduces overall risk.

Automated Rebalancing: Many modern platforms offer automatic portfolio rebalancing features that monitor order execution on both sides. This is especially useful when orders are partially filled: the system automatically places market orders to bring the portfolio into balance.

Using Margin: With sufficient supporting margin, traders can use various assets as collateral. This reduces the required capital and increases capital efficiency, though it also raises the risk of liquidation.

Monitoring Positions: After opening an arbitrage position, traders cannot fully “forget” about it. Regularly checking balances, margin levels, accumulated fees, and funding rates is essential. If rates move unfavorably or margin approaches a critical level, closing the position early may be necessary.

Frequently Asked Questions About Arbitrage

When is arbitrage most advisable?

Arbitrage is most effective in scenarios such as:

• When there is a noticeable spread between trading pairs — allowing locking in short-term profit and minimizing volatility risk.
• When managing large orders — simultaneous trading on two markets reduces price impact and improves execution.
• When diversifying strategies — arbitrage complements traditional speculative approaches.

What minimum profitability is needed for arbitrage to be profitable?

Minimum profitability depends on the total fees. If fees are 0.1% on entry and 0.1% on exit (total 0.2%), the spread should be at least 0.3–0.5% to realize profit after costs. In practice, many traders look for spreads in the range of 0.5–2%, depending on market conditions and liquidity.

Does canceling an order on one market affect the arbitrage position?

Yes, this is critical. If a trader cancels the buy order on the spot market but leaves the sell order in the futures market, they will be left with an open short position exposed to market risk. Many platforms offer linked orders that cancel both simultaneously to prevent such situations.

Is arbitrage only accessible to experienced traders?

While the concept of arbitrage is simple, execution requires preparation. Beginners are advised to start with small volumes, carefully monitor each position, and fully understand the platform mechanics before scaling up. Having sufficient capital buffer to withstand margin fluctuations is also important.

Can arbitrage guarantee profits?

Arbitrage reduces risk but does not eliminate it entirely. Improper execution, technical delays, low liquidity, sudden price jumps, or calculation errors can lead to losses. It is a risk mitigation strategy, not a guaranteed profit tool.