FINANCIAL ECONOMICS REPORT

MUHAMMAD ABID (20191-26531)

LAW OF ONE PRICE AND ARBITRAGE IN
BITCOIN

HYPOTHESES
“ARBITRAGE IS NOT POSSIBLE IN CRYPTO CURRENCY
AND IT FOLLOWS A ONE PRICE RULE”
TABLE OF CONTENT

Table of Contents
ABSTARCT 3
INTRODUCTION 4
METHADOLOGY WITH EXAMPLE 5-6
What is arbitrage trading? 6
WHY ARE CRYPTO EXCHANGE PRICES DIFFER 7
Risks associated with cryptocurrency arbitrage trading 8
REAL LIVE EXAMPLES OF BITCOIN ON MULTIPLE EXCHANGES…………………………..9
BITCOIN VALUATION THROUGH DIFFERENT CURRIENCIES……….………….……….13-14
CONCLUSION………………………………………………………………………………...…………15
REFERENCES…………………………………………………………………………………...………16
ABSTRACT
Bitcoin, a digital currency, is a textbook example of how the law of one price should be satisfied, as it is a
fully fungible asset with identical payoffs, unlike assets. Despite this, we show that there are persistent,
statistically significant discrepancies in bitcoin values in US dollars across several bitcoin exchanges.

Furthermore, the bid-ask spread, order book depth, and volatility are all positively connected to price
disparities, while volume is adversely related. On exchanges with lower trade sizes, price discrepancies
are also bigger, which is consistent with clientele impacts from increased institutional trading.

Furthermore, impulse reactions suggest that illiquidity and volatility shocks have a bigger impact on
prices and pose a greater danger. Finally, arbitrage frictions influence the speed of arbitrage and price
discovery. As a result, even in homogeneous asset classes where many of the frictions found in more
traditional asset markets are missing, arbitrage constraints remain significant.
INTRODUCTION
Assets with identical payoffs should trade at the same price, according to the law of one price. The price
disparities of the virtual currency bitcoin trading on six exchanges are investigated in this research. We
discovered consistent, statistically significant discrepancies in bitcoin prices across multiple USD
exchanges. After accounting for implicit and explicit trading expenses, we find that the average absolute
price difference for the Binance exchange pairings remains statistically significant.

Then, as predictors of bitcoin arbitrage earnings, we look at market segmentation and institutional
characteristics. Clientele effects may cause segmentation, with more active exchanges housing more
institutional traders, as inferred from trade size differences. In comparison to other exchanges, Binance
accounts for a significant portion of price discovery. These findings suggest that arbitrage frictions slow
the rate at which prices return to equilibrium and reduce the quantity of price discovery.
Methodology With Example
If the price of an economic good or security differs in two free markets after accounting for the impacts of
currency exchange rates, an arbitrageur will buy the asset in the cheaper market and sell it in the more
expensive market to make a profit. When the law of one price holds, arbitrage profits like these will
continue until market prices converge.

For example, if a security is available for $10 in Market A but sells for $20 in Market B, investors might
buy the security in Market A and instantly sell it for $20 in Market B, collecting a profit of $10 without
any genuine risk or market movement.
All other things being equal, as securities from Market A are sold on Market B, prices on both markets
should shift in accordance with changes in supply and demand. Increased demand for these assets in
Market A, where they are less expensive, should result in a price increase there.

Increased supply in Market B, where the asset is being sold for a profit by the arbitrageur, on the other
hand, should result in a drop in its price. This would eventually result in a balance of the security's price
in the two markets, bringing it back to the state specified by the law of one price.
Violations of the One-Price-Rule
In the actual world, the assumptions underlying the law of one price frequently fail, resulting in persistent
price differentials for a wide range of products and assets.

Costs of Transportation
When trading in commodities, or any physical commodity, the cost of transportation must be included in,
resulting in price differences between commodities from different regions.

If the difference in transportation costs does not account for the variation in commodity prices between
regions, it could indicate a regional shortage or excess. This is true for any item that needs to be
physically carried from one area to another rather than simply transferred in title from one owner to
another. It also applies to wages for any job that requires the worker to be physically present at the
working site in order to complete the task.
Costs of Transactions
Prices for the same commodity might vary throughout marketplaces due to transaction costs, which exist
and vary among markets and geographic regions. Where transaction costs are higher, such as the expense
of finding a suitable trading counterparty or the cost of negotiating and enforcing a contract, the price of a
good will tend to be higher than in other markets where transaction costs are lower.
Legal Constraints
Tariffs, capital controls, and, in the case of wages, immigration limits, are examples of legal trade
obstacles that can result in persistent price differentials rather than a single price. These will have an
effect similar to transportation and transaction costs, and they could even be considered a sort of
transaction cost. If a government imposes a tariff on rubber imports, for example, domestic rubber prices
are likely to be higher than world prices.
Structure of the Market
Because the amount of buyers and sellers (as well as their capacity to enter the market) varies by market,
so does market concentration and the ability of buyers and sellers to determine prices.

In a particular market, a seller with a high degree of market power due to natural economies of scale may
behave as a monopoly price setter and charge a higher price. Even for commodities that are normally
easily transportable, this can result in different costs for the same good in different marketplaces.

To calculate the arbitrage percentage, you can use the following formula:
1. Arbitrage % = ((1 / decimal odds for outcome A) x 100) + ((1 / decimal odds for outcome
B) x 100)
2. Profit = (Investment / Arbitrage %) – Investment.
3. Individual bets = (Investment x Individual Arbitrage %) / Total Arbitrage %
What is arbitrage trading?
Long before the introduction of the crypto market, arbitrage was a mainstay of traditional financial
markets. Despite this, there appears to be more excitement in the crypto world about the possibility for
arbitrage opportunities.
This is most likely due to the cryptocurrency market's significant volatility when compared to other
financial markets. This means that the prices of crypto assets tend to fluctuate a lot over time. Because
crypto assets are traded around the world on hundreds of exchanges at all hours of the day and night,
arbitrage traders have significantly more opportunity to benefit from price differences.
A trader would just need to notice a difference in the pricing of a digital asset across two or more
exchanges and conduct a series of transactions to profit from it.
Let's say the price of bitcoin on the Coinbase cryptocurrency exchange is $60,000 and $60,200 on
Kraken. Crypto arbitrageurs might notice this discrepancy and buy bitcoin on Coinbase and sell it on
Kraken to profit from the $200 price difference. This is an example of a crypto arbitrage deal in action.

WHY ARE CRYPTO EXCHANGE PRICES DIFFER

CENTRALIZED EXCHANGES
Exchanges that are centralised
The first thing to understand is that asset pricing on centralised exchanges is determined by the most
recent bid-ask matched order on the order book. In other words, the most recent price at which a trader
buys or sells a digital asset on an exchange is termed the exchange's real-time price.
If the most recently matched order on an exchange is to buy bitcoin for $60,000, this price becomes the
platform's newest bitcoin price. The price of the digital asset will be determined by the next matching
order after that. On exchanges, price discovery is a constant process of determining a digital asset's
market price based on its most recent selling price.
It's also worth noting that prices fluctuate because investor demand for an item differs somewhat between
exchanges.

DECENTRALIZED EXCHANGES
They price crypto assets using a separate process. This is referred regarded as a "automatic market maker"
approach since it relies on crypto arbitrage traders to keep prices consistent across exchanges.

Rather of using an order book system to match buyers and sellers in order to trade crypto assets at a
specific price and volume, decentralized exchanges use liquidity pools. A separate pool must be setup for
each crypto trading pair. If someone wanted to trade ether (ETH) for link (LINK), for example, they
would need to find an ETH/LINK liquidity pool on the exchange.
Each pool is sponsored by volunteers who deposit their own crypto assets in exchange for a proportionate
share of the pool's transaction fees. The key advantage of this method is that traders are not need to wait
for a counterparty (opposite trader) to respond.
The values of both assets in the pool (A and B) are maintained by a mathematical formula on the majority
of popular decentralized exchanges.
When a trader drastically changes the ratio in a pool (makes a huge deal), it might result in considerable
price disparities between the assets in the pool and their market value.

Risks associated with cryptocurrency arbitrage trading

Fees
It's important to keep in mind that trading between two exchanges can result in withdrawal, deposit, and
trading costs. These costs might add up and chip away at your income. Assume, using our original
example as a case study, that Coinbase's withdrawal costs, Kraken's deposit fees, and Kraken's trading
fees total an additional 2%. $45,000 + (2 percent * $45,000) = $45,900 is the total cost of executing this
deal. In other words, since the potential reward is only $200, the crypto arbitrage trader must have lost
money.
Timing
Time is of the essence when it comes to crypto arbitrage. The pricing differential between the two
exchanges tends to shrink as more traders take advantage of a given arbitrage opportunity.

Consider the difference in profitability between Bob and Sarah as a result of their trade timing. Bob is the
first to notice and take advantage of the arbitrage opportunity from our previous example in this scenario.
This was followed by Sarah's attempt to do the same thing.

What makes crypto arbitrage a low-risk strategy?

You may have noted that, unlike day traders, crypto arbitrage traders are not required to forecast future
bitcoin prices or enter transactions that may take hours or days to generate gains.

Traders who recognise arbitrage opportunities and take advantage of them do so with the goal of making
a fixed profit, rather than assessing market sentiments or relying on other predictive pricing
methodologies. In addition, depending on the resources available to traders, an arbitrage deal can be
entered and exited in seconds or minutes. With this in mind, we can come to the following conclusion:
1) Crypto arbitrage trading carries a lesser risk than other trading tactics because it does not
typically require predictive analysis.

2) Arbitrage traders only have to execute trades that last a few minutes at most, which reduces their
exposure to trading risk.
exceptions to the one-price rule
Bitcoin pricing should, in principle, be the same across exchanges. Bitcoin is a highly transferrable and
uniform asset. Bitcoins are completely fungible, meaning that one bitcoin can be substituted for any other.
Furthermore, bitcoin ownership can be transferred at a low cost in a short period of time.
8 As a result, an arbitrageur may theoretically profit by buying bitcoin on a less costly exchange and then
selling it or forming a short position on a more expensive exchange.
The Law of One Price, which states that the price of bitcoin should be the same regardless of where it is
acquired, should be enforced via this method. In section 4.1, we estimate price disparities across exchange
pairs and show that they are significantly and persistently different from zero. In section 4.3, we go over
the technique an arbitraguer can use to profit from a differential in bitcoin prices between two countries.
REAL LIFE LIVE EXAMPLES OF BITCOIN ON MULTIPLE
EXCHANGES

BINANCE CRYPTO EXCHANGE

The price of bit coin is $48,785.01

HUOBI CRYPTO EXCHANGE

The price of bitcoin is $48,789.40
OKEX CRYPTO EXCHANGE
The price of a bitcoin is $48,787.4

KU COIN CRYPTO EXCHNAGE

The price of a bitcoin here is $48,737.7
BITCOIN VALUE THROUGH DIFFERENT EXCHANGES
BITCOIN VALUATION THROUGH DIFFERENT CURRIENCIES

AUSTRALIAN DOLLAR bitcoin value $67474

American dollar value $48,675

EURO bitcoin value $42,931

American dollar value $48,625
GREAT BRITAIN POUND bitcoin value
American dollar value $48,735

TURKISH LIRA bitcoin value

American dollar value $50,828

A clear difference in price can be seen.

Conclusion
 Crypto arbitrage is a terrific way to generate money if you understand the risks and do it
correctly. Hedge funds, financial institutions, and investment groups, as well as individual
investors, are starting to take notice.
 The entire procedure requires little effort and yields better profits, attracting a large number of
people. Although there are hazards, they can be effectively mitigated if traders employ the
appropriate tactics. And now that quick loans are available, the entire procedure has been made a
lot easier.
 Arbitrage in cryptocurrency and Bitcoin is all about speed. Spreads may only last a few seconds
or less, thus you must be able to compare rates across exchanges in real time. As a result,
profiting from crypto arbitrage in 2020 will be very impossible unless you use a programme to
help you.

 Arbitrage in cryptocurrencies can be very rewarding. There will always be a method to profit as
long as pricing discrepancies exist (which they do). But that doesn't imply it's simple or the best
option for you.

 Crypto arbitrage trading carries a lesser risk than other trading tactics because it does not
typically require predictive analysis. Arbitrage traders only have to execute trades that last a few
minutes at most, which reduces their exposure to trading risk.

 The process of buying bitcoins on one exchange and selling them on another, where the price is
higher, is known as bitcoin arbitrage. Varying exchanges will have different Bitcoin pricing, and
some people will be able to profit out of thin air by taking advantage of this.
REFERENCES
https://coinmarketcap.com/currencies/bitcoin/markets/
https://www.binance.com/en/trade/BTC_USDT?layout=pro
https://www.huobi.com/btc/markets/prices
https://www.okex.com/btc/markets/prices
https://medium.com/coinmonks/bitcoin-arbitrage-a-beginners-guide-c8c36aa23725
https://www.investopedia.com/terms/l/law-one-price.asp
https://www.coindesk.com/learn/crypto-arbitrage-trading-how-to-make-low-risk-gains/