BTC Update Wednesday 7th August

With the Bitcoin market still trading in a tight range we have little to add to yesterday's analysis.  In sum, the market still looks 'toppy' but could go either way.  Accordingly we wouldn't advise acquiring any more bitcoin where we are currently trading but we'd be tempted to buy some more if we test and reject $101-2. Above price we will be watching how the market reacts to a re-test of resistance at $112, if and when we get there.

Right, with that out of the way, let's change gear.

A week or so back The Genesis Block published a fascinating feature on the current cross-exchange price spread of bitcoin; you can read it here:

http://thegenesisblock.com/bitcoin-cross-exchange-spreads-reach-16-month-high/

A quick look at my trading platform is telling me that while a bitcoin will currently cost you $106.70 on MtGox, it will only set you back $97.83 on BTCe.

This nine dollar spread represents a meaningful arbitrage opportunity that would not exist in a mature market. Most arbitrage trades in the contemporary context are executed around the assumption that a temporary imbalance between two different but correlated financial instruments will come back into balance, offering the potential of a fully hedged, risk-free trade.  Of course, the risk when attempting to 'arb' correlated markets is that they may not be as correlated as you think.

But what we are talking about here is bitcoin's correlation to itself. When considered from this standpoint, the current inter-exchange imbalance offers the perfect, textbook, arbitrage opportunity, right? What we mean is, the current inter-exchange spread HAS to re-balance at some point.

So, with this established, how might we take advantage of it?

Well, until the recent arrival of bitcoin derivative instruments, a bitcoin arbitrage trade would not have been straightforward as a trader did not have the possibility of 'shorting' bitcoin in any other way than holding the fiat.  BUT with the arrival of derivative exchanges like BTC.sx it is now possible to go short bitcoin and, better still, BTC.sx's counter-party is the exchange currently offering bitcoin at the higher price.

So, to execute this 'arb' trade all a trader has to do is buy bitcoin from BTCe and simultaneously sell a position of the equivalent size on BTC.sx.

Let's do some figures to bang this little nail home. And since the biggest position you can take on BTC.sx would amount to 200 bitcoins, let's use this as our example:

So let's say we buy 200 bitcoin from BTCe and simultaneously initiate a short position of identical size on BTC.sx.

What you have now is a fully hedged arbitrage trade, with movement of price one way cancelled out by one side of your trade or the other.  Indeed the only risk you carry is the counter-party risk that either BTCe or BTC.sx implode while your trade is live.

What you KNOW is that assuming both stay in business, the current X-exchange imbalance has to narrow - and if you catch all of it, you stand to make around $1800 when their prices re-align; you just don't know when.

Now clearly, not all of us readily wield a ready trading pool of 400 bitcoin, but the maths work regardless of the sizes involved.  The crucial concept here is careful planning and slick execution to ensure that your position is entirely hedged.

'Makes you think doesn't it...?!

By Rob @ Bitscan.