Limits to Arbitrage refers to the practical constraints and market frictions that prevent arbitrageurs from fully exploiting price discrepancies across financial markets, including those for cryptocurrencies. These limitations imply that asset prices may deviate from their fundamental values or theoretical relationships for extended periods, despite the presence of rational traders. Factors include transaction costs, funding costs, and risks associated with maintaining arbitrage positions.
Mechanism
The operational mechanism behind limits to arbitrage involves several systemic frictions. Transaction costs, such as trading fees, blockchain gas fees, and slippage, directly reduce potential arbitrage profits. Funding costs arise from borrowing assets or capital necessary to execute arbitrage strategies, a particularly significant factor in volatile crypto lending markets. Furthermore, arbitrageurs face various risks, including execution risk (orders not filling as expected), basis risk (hedging instruments not perfectly tracking the underlying), and liquidity risk (difficulty closing positions). These factors collectively restrict the effectiveness and scalability of arbitrage operations.
Methodology
Understanding limits to arbitrage informs the strategic methodology of both arbitrageurs and other market participants in crypto. Arbitrageurs must factor these costs and risks into their quantitative models, seeking discrepancies large enough to overcome them, and employing robust risk management to prevent adverse market movements from eroding capital. For institutional traders, recognizing these limits can explain persistent pricing inefficiencies, allowing for alternative strategies that capitalize on these structural market characteristics rather than assuming instant price correction. This perspective acknowledges that even efficient markets have boundaries to perfect price alignment.
We use cookies to personalize content and marketing, and to analyze our traffic. This helps us maintain the quality of our free resources. manage your preferences below.
Detailed Cookie Preferences
This helps support our free resources through personalized marketing efforts and promotions.
Analytics cookies help us understand how visitors interact with our website, improving user experience and website performance.
Personalization cookies enable us to customize the content and features of our site based on your interactions, offering a more tailored experience.
