How does crypto arbitrage exploit exchange price differences?

Mechanics of crypto arbitrage

Arbitrage in cryptocurrency markets takes advantage of price differences for the same digital asset across exchanges or trading pairs. Traders monitor multiple centralized exchanges and decentralized exchanges to find situations where, for example, Bitcoin trades at a higher price on one platform than another. A simple cross-exchange arbitrage involves buying the asset where it is cheaper and selling where it is dearer. A triangular arbitrage exploits price discrepancies among three trading pairs within a single exchange by cycling through currencies to end up with more of the starting asset. Market microstructure research and industry reports show that fragmentation of trading venues creates these opportunities. Garrick Hileman and Michel Rauchs at the Cambridge Centre for Alternative Finance University of Cambridge document that liquidity is dispersed across many platforms, which produces persistent but often short-lived price differences.

Successful arbitrage requires speed, capital, and an understanding of transaction frictions. Traders must factor in trading fees, taker and maker fee schedules, withdrawal costs, deposit and withdrawal limits, and blockchain settlement times when moving assets on-chain. Some arbitrageurs pre-fund accounts on both sides of a spread to avoid slow transfers, effectively carrying inventory and counterparty risk. Others use flash loans or cross-exchange credit to reduce capital tied up. High-frequency and algorithmic strategies rely on low-latency connectivity and co-located infrastructure to reduce execution delays that can erase expected profits.

Limits, risks, and wider effects

Arbitrage is constrained by practical and regulatory frictions that prevent perfect price alignment. Exchange reliability, withdrawal delays, and anti-money-laundering checks can make cross-border transfers slow or impossible in practice. John M. Griffin at the University of Texas at Austin has highlighted scenarios where market distortions and manipulative practices affected prices, illustrating that not all observed spreads are purely innocuous profit opportunities. Counterparty risk is material: exchanges can freeze withdrawals or become insolvent, turning a profitable trade on paper into a realized loss.

Beyond direct profit-seeking, arbitrage influences market efficiency and local price formation. When arbitrage activity is robust, it tends to compress spreads and improve price discovery across venues. Conversely, where capital controls, fiat on-ramps, or cultural factors drive localized demand, persistent premiums can emerge. The so-called kimchi premium in South Korea during peak demand episodes reflects how territorial regulatory frameworks, tax treatment, and retail enthusiasm can sustain price gaps that attract arbitrageurs despite elevated risks. Environmental and infrastructural conditions also matter: regions with limited internet access or fewer local exchanges face different frictions than global hubs, affecting how quickly price discrepancies close.

Regulators and market participants monitor arbitrage both as a symptom of fragmentation and as a source of systemic stress during volatility. While arbitrage generally supports market integration, excessive reliance on pre-funded positions, leverage, or opaque liquidity can amplify shocks if exchanges halt transactions. Understanding the mechanics, frictions, and socio-territorial drivers behind arbitrage is essential for traders, policymakers, and communities that engage with crypto markets.