Introduction

This post tries to explain arbitrage using day to day example.

Not just one price

Picture a farmers market; in there, each farmer sells his own products. If you consider just one product as meat, products from all farmers are basically the same. Although there's no rule for price setting,  prices usually are very similar due to the natural supply and demand law. There can be some small differences, but as they're all in the same market, competition will make prices converge. Now consider a large metropolitan area, there are several farmers markets, as they usually don't have the same clients, there will be bigger price differences between those markets than between farmers on the same market.

With cryptocoins, it's basically the same. There are several exchanges on the internet; on each one there are people trying to sell and buy the same product(cryptocoins) so prices on each one are determined by supply and demand on the exchange. As each exchange has it's own users, prices between them can be different.

The spread

Imagine farmers from one market from the previous example decide to sell their products considerably cheaper than the other markets. Eventually, people that shop in the other market will realize the situation and start shopping there. Wich will lead to one of two possibilities: 

1. Farmer from that market will realize they can profit more as there's more demand and start raizing their prices.
2. Farmer from other markets will realize they are losing clientele and lower their prices.  

After a while, the prices from all markets will come close either to the price from the lowest or the price from the lowest will increase till it's the same or they all meet up somewhere in the middle.

With digital assets, it's the same. If suddenly there's a big price drop in one exchange, people will start moving resources from one to another till prices become very similar.  As there's no frontiers, nor geographic distances in the internet, prices in all exchanges of the world remain basically the same.  This is called the spread.

Beating the spread

Continuing our example, if someone notices this price difference before the spread and decides to profit from it, he could buy the meat from the market with the low price take it to any other market and sell it there.  Thus beating the spread.

That's what bitcoin arbitrage is: observing various exchanges to identify any differences and try to profit by beating the spread. When an investor (or group of investors) from one exchange decide to sell a really big amount of asset, the price in that exchange goes down. As bitcoin 'markets' are all online, these markets are intertwined and the spread happens very quickly but a user can take advantage of this before the spread. 

Arbitrage methods

There are several ways of doing arbitrage after you identify a price difference. The easiest ways to start with would be:

1. Buy and transfer: Buy on the exchange with the lower price, transfer to your bitcoin wallet on the other exchange and sell. Although this is the best way, it will only work if the price difference is considerable as you´ll have to pay all the fees included in a BTC transaction.
2. Having resources in both exchanges: If you have available balance in both exchanges, you can buy on the cheaper and sell the same amount bought on the one with the higher price.  Eventually, while you repeat these transactions with opposite 'directions' your balance will increase. The problem with this is that you need to divide your resources into 2 exchanges, in one you´ll need to have BTC and on the other you´ll need to have the base currency. Eventually, you´ll only be able to perform the operations that match your current balance.