Instead, an AMM determines the price of the asset in each liquidity pool by analysing the pool’s internal supply and how it balances with its trading pair. This means prices on an AMM automatically change depending on the demand within its own, closed ecosystem, rather than dynamics of the wider market. For example, imagine a liquidity pool holding ten million dollars of Ether (ETH) and ten million dollars of USDC. A trader decides to swap $500k if their own USDC for ETH using the AMM.

Trading Crypto Currency

Plus, the whole strategy is inherently low-risk. To explain, these automated arbitrage bots can spot an opportunity then execute the trade within seconds. This is because flash loans are technically advanced, and therefore tend to be limited to advanced traders rather than a retail audience (for now). That said, it’s not the simplest strategy to execute. This leads to opportunities for other crypto arbitrageurs becoming scarcer than ever. Flash loans are also a playground for bots as they allow for automated arbitrage trading.

The time inefficiencies of blockchain can also add a risk factor to your strategy. While arbitrage trading can look easily profitable on the surface, it’s important to note that withdrawing, depositing and trading crypto assets on exchanges usually incurs fees. Finally, since exchanges interact with the blockchain and the internet, they can fall victim to network outages and server issues. Alternatively, they might decide not to serve a certain geographical location due to legal sanctions on or in specific countries. You can also have legal barriers, such as anti money laundering checks or geo-blocking. For example, an exchange can halt transactions for hours whilst investigating. For example, blockchain transaction speeds are sometimes so slow that the price could change by the time the transaction is approved.

Using triangular arbitrage strategies, they may exchange an amount of BTC to ETH at one rate, then convert the ETH to XTZ for another rate, then finally, exchange the XTZ back to BTC. There are also often price differences between different decentralized exchanges (DEXs). This is because decentralized exchanges do not support custodial crypto wallets. This has the advantage of incurring less fees than using a centralized exchange – as well as enabling the trader to retain full control of their private keys for the entirety of the process. Decentralized arbitrage traders seek out pricing discrepancies between DEXs. Trading focused on AMMs is known as decentralized arbitrage. Price differences don’t just occur between centralized exchanges and AMMs.