How does crypto arbitrage exploit price discrepancies?

Crypto arbitrage exploits price discrepancies by buying an asset where it is cheaper and selling where it is more expensive, capturing the spread after costs. In cryptocurrency markets those discrepancies arise because trading venues are fragmented, settlement is sometimes slow, and regulatory, liquidity, and technological conditions differ across jurisdictions. Andrei Makarov and Antoinette Schoar of the National Bureau of Economic Research document persistent cross-exchange differences and emphasize that frictions such as withdrawal limits and funding constraints often prevent instantaneous convergence.

Mechanics of exploitation

Traders use automated systems to monitor multiple exchanges and spot price gaps in real time. When a meaningful spread appears an arbitrageur executes offsetting orders and moves the asset or the counterparty funds to balance exposure. Execution requires careful accounting for fees withdrawal delays network congestion and funding or margin costs. In practice successful arbitrage often relies on prepositioned inventory on several exchanges or on derivatives like futures to hedge while on-chain transfers settle. Speed and capital access matter: latency advantages give high frequency firms an edge while smaller participants face higher relative costs.

Causes and consequences

Several structural causes sustain arbitrage opportunities. Market fragmentation creates isolated order books and variable liquidity across platforms. Regulatory differences and local capital controls can block or delay movement of fiat and crypto leading to regional premiums. Know your customer rules and anti-money laundering checks add onboarding delays that limit the mobility of retail flows. Exchange counterparty risk and limits on withdrawals create asymmetric exposure that discourages full exploitation of spreads. The consequence is a mixed welfare effect. On one hand arbitrage tends to improve price efficiency by aligning prices across venues when execution is feasible. On the other hand persistent frictions mean that arbitrage profits accrue to firms with superior technology capital or regulatory access reinforcing concentration in trading.

Human and territorial nuances amplify these dynamics. In countries where citizens face rapid inflation or capital controls localized demand can push up crypto prices relative to international markets, creating larger but riskier arbitrage prospects for those who can move funds cross-border. Traders in lower trust environments confront added counterparty risk and may prefer on-chain settlement despite higher transaction energy costs on proof of work chains. Environmental considerations appear when arbitrage strategies increase on-chain traffic during congestion periods raising energy use per trade and worsening network fees for other users.

Practical and systemic risks remain significant. Transaction costs network delays and counterparty defaults can turn apparent spreads into losses. Regulatory interventions, including restrictions on withdrawals cross-border transfers or derivatives trading, can freeze arbitrage channels and amplify local volatility. Empirical research by established economists and institutions shows that while arbitrage contributes to market integration it does not remove all price differences because of the real world frictions that shape how quickly and safely value can travel between people places and platforms.