Triangular arbitrage? What does it mean? What makes this concept so sweet to practice by experienced traders? This and many more is what I will be writing on in this week's crypto academy contest.
The contest tips will be a guide as i explore on this topic.
Explain in your own words, What is triangular arbitrage?
Triangular arbitrage occurs when there is a discrepancy between the cross rates of three currency pairs. So traders just take advantage of these price differences to make profit.
In order to be certain of profitability, the trade is performed very quickly and the transaction is usually huge in size, it involves large amount of money.
This opportunities created by differences in exchanges rates of an asset, lead the exchanges to becoming more efficient.
This usually happen between 3 quoted pairs.
Most traders automate this triangular arbitrage, such that even when they are asleep and the system notices the discrepancy, it quickly carries out the transaction.
However, this is also risky because if it is not done quickly, the traders will end up losing much money.
How to do triangular arbitrage trading?
Like I said earlier, triangular arbitrage occurs when the rates of three quoted currency pairs does not match.
For example, if rate of EUR/USD is fine, and EUR/GBP is fine too, but GBP/USD is lower, that means the trader will make additional money when selling the GBP for USD.
To illustrate, assuming a person has a huge amount of money let us say $2 million dollars and want to engage in triangular arbitrage, he will take note of the cross rates between the currency he has and the two other currencies. In this case he has dollars, the discrepancy is between EUR/GBP pair.
The pair EUR/USD rate is 1.1566, EUR/GBP = 1.145 and GBP/USD =1.6819. Remember that all you need to make money is just a fraction of cent
Use the $2 million dollars to buy Euros :- $2m ÷ 1.1566 = €1,729,206.29
Then sell the EUR for GBP:- €1,729,206.29 ÷ 1.145 = £1,510,223.83
Then use the GBP to buy USD:- € 1,510,223.83 x 1.6819 = $2,540,045.46
So when you subtract the last USD value from the initial investment, the trader will be making a profit of $540,045.46.
This is certainly a huge profit, within few seconds.
Ordinarily, when you start with $2 million, you should end up with $2m or even less due to exchange charges
So for you to trade a triangular arbitrage, we need to
° identify that such opportunity exist and then the pairs involved.
° Determine the profit to be made if you are to take the process
° the trader needs to calculate the transaction cost to be sure it is cost effective.
° Effective risk management is important too. Only carry out the trade with a capital that you can afford to lose.
° Start the process and execute the transaction as quickly as possible. Here efficiency comes into play. Any time wastage or network lag, can lead to a lot of losses.
Then take your profit and wait for the next nice opportunity.
What is the difference between arbitrage and triangular arbitrage?
| Arbitrage | Triangular Arbitrage |
|---|---|
| It involves two pairs that are identical | It involves 3 unidentical pairs. |
| The transaction is done in two different exchanges or locations or markets | This is done in the same exchange or currency market. |
| This is the general name for such transactions | this is just a type of arbitrage |
Do an example of triangular arbitrage, having 10,000 Steem as the first cryptocurrency. You can choose the remaining 2 cryptocurrencies.
I have ten thousand steem and want to do an arbitrage with it. I am going to select pairs that I will do that with.
The pairs are STEEM/ETH, ETH/BTC, STEEM/BTC
As at the time of writing STEEM/ETH was $0.0001209, ETH/BTC was $0.05315 and STEEM/BTC = $0.00000662.
Selling 10000 STEEM/Eth will be = 10000x0.0001209 = 1.209 ETH.
Selling ETH/BTC = 1.209ETH x 0.05315 which will give us 0.064258BTC.
Then buying STEEM/BTC = 0.064258 X 0.00000662 = 9706 STEEM.
This is how to engage in triangular Arbitrage. Unfortunately, the one we did culminated into a loss. That simply means that there was no opportunity to carry out a triangular Arbitrage for steem currency at that time.
Conclusion
Triangular Arbitrage is a way of making money. However, care must be taken to avoid unnecessary losses. The trader must have practiced this on dummy trading environment to ensure it works before investing a large sum into it.
I invite @casv @drhira @yancar in this contest. Success to you all!
This is my introductory post here