5 DeFi Arbitrage Strategies in Crypto to Know

DeFi arbitrage is not a one-size-fits-all strategy. There are various ways to execute it, depending on the platform and the market conditions. Some of these ways involve decentralized applications (dApps), while others include centralized exchanges (CEXs) like Binance, Okex, etc. 

In this section, we will cover some of the most popular and effective DeFi arbitrage strategies and how they work.

1. Triangular Arbitrage

This is a strategy that leverages real-time price differences among three assets on the same platform or exchange. For example, if you can buy ETH with USDT, then buy DAI with ETH, then sell DAI for USDT, and end up with more USDT than you started with, you have performed a triangular arbitrage.

Suppose you have 1000 USDC and you see the following prices on Uniswap: 

• 1 ETH = 4000 USDC

• 1 DAI = 1.01 USDC

• 1 ETH = 3900 DAI

You can perform a triangular arbitrage by:

1. Buying 0.25 ETH with 1000 USDC 

2. Buying 975 DAI with 0.25 ETH 

3. Selling 975 DAI for 984.75 USDT

You will have made a profit of 15.25 USDC minus transaction fees.

2. Cross-Exchange Arbitrage

This involves exploiting price differences for the same asset across different platforms or crypto exchanges. For example, if you can buy ETH for a lower price on Uniswap and sell it for a higher price on Kyber, you have performed a cross-exchange arbitrage.

Suppose you have 1 ETH and you see the following prices on Uniswap and Kyber: 

• 1 ETH = 4000 USDT on Uniswap

• 1 ETH = 4100 USDT on Kyber. 

You can perform a cross-exchange arbitrage by:

1. Buying 1 ETH for 4000 USDT on Uniswap

2. Selling that 1 ETH for 4100 USDT on Kyber:

You have made a profit of 100 USDT minus gas price.

3. Yield Arbitrage

This is a strategy that takes advantage of interest rate gaps for the same digital asset across different platforms or protocols. 

For example, if you can lend DAI at a higher rate on Compound and borrow DAI at a lower rate on Aave, you have performed a yield arbitrage.

Suppose you have 1000 DAI and you see the following interest rates on Compound and Aave: 

• Compound offers 10% APY for lending DAI and 12% APY for borrowing DAI

• Aave offers 8% APY for lending DAI and 10% APY for borrowing DAI

You can perform a yield arbitrage by lending 1000 DAI on Compound and earning 100 DAI in a year, then borrowing 1000 DAI on Aave and paying 100 DAI in a year. You have made a profit of zero minus gas fees, but you have also gained access to another 1000 DAI that you can use for other purposes.

4. Market Making 

Though not directly arbitrage, market making is a popular way to earn yield in DeFi.

This process involves providing liquidity to a market and earning fees or rewards from trades. For example, you can deposit ETH and DAI into a Uniswap pool and earn fees from every swap that involves ETH or DAI.

Suppose you have: 

• 1000 USDT and 0.25 ETH 

And you see the following prices on Uniswap: 

• 1 ETH = 4000 USDT

You can perform market-making by depositing your USDT and ETH into the Uniswap pool and earning fees from every trade that involves USDT or ETH. For example, if someone swaps 100 USDT for 0.025 ETH, you will earn a fee of 0.3% of the trade value, which is 0.3 USDT or 0.000075 ETH.

A risk associated with crypto market making is impermanent loss. 

📚 Read: What Are Automated Market Makers (AMMs)? 

5. Trade Batching and Flash Loans Arbitrage

This involves combining multiple trades in one transaction and using flash loans to execute complex arbitrage strategies and algorithms without upfront capital. 

An example of a trade batching and flash loan would be if you:

1. Borrow DAI from Aave using a flash loan

2. Swap it for ETH on Uniswap

3. Swap it for USDT on Kyber

4. Repay the flash loan to Aave

5. Keep the difference in USDT stablecoin

Suppose you have no capital or crypto assets and you see the following prices and interest rates on Aave, Uniswap and Kyber: 

• Aave offers flash loans for DAI at a fee of 0.09%

• Uniswap offers 1 DAI = 1.01 USDT

• Kyber offers 1 DAI = 1.02 USDT 

You can perform a batching and flash loans arbitrage by:

1. Borrowing 10000 DAI from Aave using a flash loan

2. Swapping it for 10100 USDT on Uniswap

3. Swapping it for 9901.96 DAI on Kyber

4. Repaying the flash loan to Aave with a fee of 9 DAI

5. Keeping the difference of 7.04 DAI minus gas fees

Conclusion

DeFi arbitrage is a profitable but tricky way to make passive income in the DeFi space. It involves exploiting price or interest rate gaps across different exchanges and different markets using various strategies and tools. But DeFi arbitrage also demands technical skills, market knowledge, and risk management. DeFi arbitrage opportunities are always changing and evolving as new platforms and protocols pop up. So DeFi arbitrageurs need to keep up and adapt to the dynamic DeFi landscape.