What Is Triangular Arbitrage and How to Use It?

This type of arbitrage is common in the foreign exchange (forex) market, but also applies to the cryptocurrency markets where coins are traded in multiple pairs.

How Triangular Arbitrage Works

The process involves converting one currency to another, then converting it to a third, and finally converting it back to the original currency. If the final amount is greater than what you started with, you've made a profit.

Steps in Triangular Arbitrage:

1. Start with a base currency (e.g., USD)
2. Convert it to a second currency (e.g., EUR)
3. Convert the second currency to a third (e.g., GBP)
4. Convert the third currency back to the base currency (e.g., USD)

Real-World Example (Forex)

Suppose you notice the following exchange rates in the forex market:

• USD/EUR = 0.90
• EUR/GBP = 1.20
• GBP/USD = 1.10

Now, let’s execute a triangular arbitrage with $1,000.

1. Convert $1,000 to EUR at 0.90 → €900
2. Convert €900 to GBP at 1.20 → £750
3. Convert £750 to USD at 1.10 → $825

In this case, you’ve ended up with $825 — a loss. This indicates the market is efficient at these rates. But if the final amount had been, say, $1,050, the $50 difference would be the arbitrage profit.

Real-World Example (Crypto)

Imagine these crypto pair prices on an exchange:

• BTC/USDT = 30,000
• ETH/BTC = 0.07
• ETH/USDT = 2,200

Now, suppose you have 1 BTC. Let’s follow the triangle:

1. Convert 1 BTC to ETH → 1 / 0.07 = 14.285 ETH
2. Convert 14.285 ETH to USDT at 2,200 each → 31,427 USDT
3. Convert 31,427 USDT back to BTC at 30,000 → 1.047 BTC

Profit: 1.047 BTC - 1 BTC = 0.047 BTC (≈ $1,410 at that rate)

Why Triangular Arbitrage Occurs

• Price differences between markets or trading pairs
• Latency in exchange rate updates
• Low liquidity in some pairs
• Human or algorithmic pricing errors

Risks and Considerations

• Execution Speed: Delays can erase the arbitrage opportunity.
• Trading Fees: Multiple conversions mean higher transaction costs.
• Slippage: Actual execution prices may differ from quoted prices.
• Market Risk: If prices change mid-trade, you could face a loss.

Tools for Triangular Arbitrage

• Automated trading bots or scripts
• Real-time price monitoring tools
• Multi-exchange APIs for fast execution

Conclusion

Triangular arbitrage is a clever trading strategy that takes advantage of price discrepancies between three markets or currencies. While it can be profitable, it's usually exploited by high-frequency trading systems due to the need for speed and precision. Traders should always account for transaction fees, latency, and slippage before executing such strategies.