Arbitrage is the practice of quickly trading the same asset in different markets to take advantage of price differences between markets. Arbitrage traders take advantage of these price differences by quickly buying an asset where it is cheaper and then selling it in the market where it is priced higher. This is due to the nature of markets like stock and cryptocurrency exchanges, where market players will always have varying degrees of access to information, trading tools and strategies, transaction costs, and human psychology, among other things.
Arbitrage traders (called arbitrageurs) profit from the markets while also making them more efficient, ensuring the same asset is similarly priced across different exchanges. Through buying on the cheaper exchange and selling on the more expensive one, these traders narrow the “spread” that exists between these exchanges. This, in turn, reduces the inefficiencies of these exchanges and shortening the window of opportunity for further arbitrage.
The development of technologies, such as automated trading, tends to eliminate opportunities for arbitrage trading much more quickly, making the practice more difficult for traders. However, as long as markets remain imperfect, arbitrage will continue to perform its vital function.