Triangular Arbitrage is used when a trader would like to use the opportunity of exploiting the arbitrage opportunity from three different FX currencies or Cryptocurrencies. Triangular Arbitrage happens when there are different rates within the trading venue/s.
In practice, Triangular Arbitrage refers to a trading opportunity when there’s a discrepancy between the rates of three currencies such that they do not exactly match up. One can then place simultaneous trades to buy one currency and sell another, both trades being conducted in a third currency, and benefit from the discrepancy in exchange rates.
Here’s an example. Let’s say the BTC to the XRP exchange rate is 0.00002645. So, when you spend 1 BTC, you get 31697.38 XRP. With this 31697.38 XRP, you purchase Ethereum XRP to ETH exchange rate of say 677.0367. So, you now have 56.98 ETH If the ETH to BTC exchange rate is 56.17, then you can exchange your 56.98 ETH for BTC and get back 0.81 ETH. Here, you’ve successfully executed a Triangular Arbitrage by spending 1 BTC and getting back BTC 1.014. That’s the profit with no risk since these trades are conducted simultaneously.
Disclaimer: the rates and numbers provided on the rates are for example purposes only and do not portray the real situation of the market.
Essentially Triangular arbitrage exploits an inefficiency or imperfection present in the market where one currency is overvalued while another is undervalued. Triangular Arbitrage is also known as Cross Currency Arbitrage or Three-Point Arbitrage.
Traders who would like to take advantage of Triangular Arbitrage need to consider the trading fee, on some occasions the fee to perform the Triangular Arbitrage could surpass the profit of the process.