Given the growing levels of technical efficiencies across markets, arbitrage requires fast-acting trades to capitalize on price discrepancies, which are often short lived. Many investors and automated investment algorithms are dedicated to finding and exploiting potential arbitrage opportunities.
In today’s highly technical markets, arbitrage opportunities may present themselves and be exploited in a matter of seconds. Trading activity, access to the market or asset, and available liquidity impact how large — and how available — the arbitrage opportunity may be.
In the context of basic Decentralized Finance (DeFi) trading activity, retail investors should keep a few elements in mind before making trades:
The Size of the Price Discrepancy
Consider the amount of opportunity available in this situation. Is the price difference between an asset on different markets particularly large? It’s probably not worth your time and effort if you’re only going to profit a few dollars in a trade. Additionally, available liquidity plays an important role: if you’re trading assets with limited liquidity, you’re likely going to experience significant slippage which may result in an unprofitable outcome.
The Size of Your Position
How much of an asset will you need to buy and sell? Keeping in mind that, at all times, other traders (and automated investment algorithms) are seeking arbitrage opportunities, too. You should not be committing a large portion of your capital to exploit an arbitrage opportunity, especially if the risk-reward is not worth the effort or the capital.
The Gas to Migrate Funds
As a DeFi investor, you’re already familiar with how blockchains work, and the gas fees associated with moving funds into various protocols. If you’ve found an arbitrage opportunity that will net you $50, but the gas fees are going to cost $15, you may determine this trade is not worth your time, especially when combined with other considerations.
The Trading Fees
Depending on the protocol or platform you’re using, you’re going to incur some kind of trading fee. Centralized exchanges may charge more than some Decentralized Exchanges (DEXs) and that may impact your decision making. Additionally, keep in mind that available liquidity may prevent you from selling your entire amount of the asset at the desired sell price. If you need to migrate funds to various markets to sell your position, these fees will cut into your potential profits.
Based on your location and jurisdiction, you’re likely going to be required to pay taxes on your potential profits based on this trade. Assets traded or sold within shorter time frames, for example, are typically taxed at a higher rate than assets held over the long term.
For example, US-based investors must stay mindful of short- and long-term capital gains taxes. This topic can add complexity and nuance to your decision making process.