What is Arbitrage: A Complete Guide to Trading Strategies in Crypto

Arbitrage is one of the most stable trading strategies in financial markets, including the cryptocurrency market. What does this mean in practical terms? Arbitrage is a method of extracting profit from the price difference of the same asset on different markets or at different times.

In the cryptocurrency market, there are various platforms, exchanges, and types of trading (spot trading, futures, perpetual contracts), where the same asset, such as Bitcoin, can have different prices. These price differences allow traders to utilize arbitrage opportunities to generate profits, regardless of the overall market trend.

Main Types of Arbitrage in Spot and Derivative Markets

In crypto, there are three main directions of arbitrage, each operating on its own principles.

Spot Arbitrage — the classic form where a trader simultaneously buys an asset on one exchange and sells it on another if the price is higher there. This is the simplest form, requiring minimal knowledge of derivatives.

Time Arbitrage — exploits the difference between the current spot price and the price of perpetual contracts (perpetual futures). This method is related to the so-called funding rate — a fee paid between long and short position holders.

Spread Arbitrage — based on price differences between perpetual contracts and standard futures with fixed expiration dates. When the futures price deviates from the spot price, opportunities for profit arise as prices converge.

How Funding Rate Arbitrage Works

To understand this mechanism, it’s important to know that perpetual contracts include a periodic funding rate. This rate is paid between market participants — those holding long positions (expecting growth) pay fees to those holding short positions (expecting decline), or vice versa.

When the funding rate is positive, long positions pay short positions. In this case, a trader can apply a strategy sometimes called “positive arbitrage”: simultaneously buy the asset on the spot market and open a short position in perpetual contracts. By hedging one position with the other, the trader minimizes market risk and profits from the funding rate difference.

For example, suppose a perpetual contract on BTC has a positive funding rate of +0.01%. The trader can buy 1 BTC on the spot market at a price of 30,000 USDT and simultaneously open a short position in 1 BTC in perpetual contracts. If the price rises, profit on the spot position offsets losses on the short futures, and vice versa. Meanwhile, the trader receives funding payments periodically, as their short position receives payments from long positions.

When the funding rate is negative, the logic is reversed. The trader opens a short position on the spot market (if possible) and a long position in perpetual contracts, earning funding on the long position.

Spread Arbitrage: How Profit Is Made

Profit from spreads is based on the convergence of the futures price to the spot price as the contract approaches expiration. When the futures price differs significantly from the spot price, an opportunity window opens.

Profit calculation from the spread looks like this:

Spread = Futures contract sale price − Spot purchase price

Spread percentage = (Futures sale price − Spot purchase price) / Futures sale price × 100%

Annualized return (APR) of the spread = (Current spread / days until expiration) × 365 / 2

The division by 2 in the denominator accounts for the fact that capital is simultaneously frozen in two positions.

Example: if BTC’s spot price is $45,000 and the 90-day futures price is $46,500, the spread is $1,500. With proper capital management and accounting for fees, a trader can lock in this difference as profit when the contract expires and prices converge.

Risks and Capital Management in Arbitrage

Despite its reputation as a low-risk method, arbitrage has significant pitfalls that must be considered.

Liquidation risk. Partial execution of orders on both markets can lead to position imbalance, resulting in insufficient collateral and potential liquidation. For example, if a trader places an order to buy 1 BTC on the spot and sell 1 BTC in a perpetual contract, but only 0.5 BTC executes on each side unevenly (0.5 BTC on spot, only 0.3 BTC in contracts), positions become unbalanced.

Slippage and market movements. Placing large orders can move the price, leading to unfavorable execution and eating into profits.

Fees. Trading commissions, funding fees, and other charges can significantly reduce expected profits, especially with small spreads.

Insufficient margin. Opening positions on both markets requires adequate collateral. If margin is insufficient, orders simply won’t execute.

When to Use Arbitrage: Practical Scenarios

Arbitrage is most effective in the following situations:

Pronounced market spreads. When there is a clear price difference between two trading pairs or instruments (within 1-3%), conditions are favorable for spot arbitrage or spread arbitrage.

High funding rates. When the funding rate exceeds 0.1% per day (roughly 36% annually), funding rate arbitrage becomes attractive. This often occurs during sharp market movements when one side (long or short) becomes overbought.

Large orders. If a trader or trading fund needs to buy or sell large amounts, using arbitrage structures helps minimize market impact and slippage.

Hedging strategies. If a trader holds a position in one market segment (e.g., spot) and wants to protect it from market risk, arbitrage allows locking in the price via an opposite position in derivatives.

Closing multiple positions. When it’s necessary to close several positions on different markets simultaneously, a structured approach reduces the risk of missed opportunities.

Calculating Profitability Metrics in Arbitrage

To evaluate arbitrage opportunities, several key metrics are used.

For funding rate arbitrage:

Total funding rate over 3 days = sum of all funding rates over the last 72 hours

Annualized return (APR) = (Total funding over 3 days / 3) × (365 / 2)

The division by 2 reflects that the capital is engaged on two markets simultaneously.

For example, if the total funding over three days is +0.09%, the annualized return is approximately (0.09 / 3) × (365 / 2) ≈ 5.5%. With minimal fees, this can be a reasonable additional income.

For spreads:

Maximum profit period = days until futures expiration

Annualized spread return = (Spread percentage) × (365 / days) / 2

If the spread is 2% until the contract’s expiration in 30 days, the annualized return is approximately (2% × 365 / 30) / 2 ≈ 12.2%.

Frequently Asked Questions About Arbitrage

Does arbitrage guarantee profit?

No. While arbitrage is considered a lower-risk strategy, it does not guarantee profit. Slippage, fees, liquidation risk from imbalance, and market volatility can lead to losses.

What should be the minimum margin to start arbitrage?

It depends on the chosen pair and platform. For example, with a margin of 30,000 USDT and BTC price at 30,000 USDT, you can open a 1 BTC position on both markets (spot and derivatives). It’s advisable to keep a safety cushion above the minimum.

How to choose between funding arbitrage and spread arbitrage?

When the funding rate is high (above 0.1% daily), funding arbitrage is often more predictable and profitable. Spread arbitrage works better when there is a significant price deviation between instruments, especially near expiration.

Can arbitrage be used to close existing positions?

Yes, arbitrage can be used both for opening and closing positions. It’s often employed when needing to close multiple positions on different markets simultaneously, minimizing market impact.

Are there restrictions on using arbitrage on sub-accounts?

Depending on the platform, there may be restrictions. Usually, arbitrage is available on main accounts with support for advanced management tools (e.g., unified trading accounts).

Why do orders sometimes not execute?

Main reasons include insufficient margin for simultaneous execution on both markets, lack of liquidity on one side, or very tight limit order prices. Ensure your available margin covers both positions.

What happens if automatic rebalancing is disabled?

If the automatic rebalancing mechanism is turned off, the platform will not automatically correct imbalances between executed orders. This increases the risk of imbalance and potential liquidation during significant market movements.

Is arbitrage available in demo trading?

Most platforms do not offer arbitrage in demo mode due to the complexity of simulating synchronous execution on two markets and the need for real liquidity data.

What margin mode is used in arbitrage?

Arbitrage typically operates in cross-margin mode, meaning the entire available account balance is used as a single collateral pool for both directions. This provides greater flexibility but requires careful risk management.

In summary, what is arbitrage? It’s a highly specialized method requiring understanding of market mechanics, mathematical calculations, and disciplined risk management. When applied correctly and with awareness of all risks, arbitrage can become a valuable part of a portfolio trading strategy.