Arbitrage
Contents
Introduction
The ripple network provides many opportunities for manual and automatic arbitrage.
Some types of arbitrage
Liquidity Taking
One form of aribtrage involves finding the difference in prices between offers in different markets, and then taking those offers, removing liquidity, and earning a profit in so doing.
For example, if BTC trade for $220 at BitStamp and $210 at Mtgox, someone can sell their BTC at Bitstamp and buy BTC again at Mtgox, netting a $10 profit.
Liquidity Making
Another form of arbitrage involves placing offers to take advantage of the differences in markets.
For example, someone is buying BTC at Bitstamp at $24 each and someone is buying BTC at Mtgox at $20 each. The arbitrager offers to buy BTC at $22 each at Mtgox. When their offer is taken, they turn around and sell those BTC an Bitstamp for $24 each, netting a $2 profit.
Cross currency Arbitrage
People may wish to convert from one form of currency to another. For example, from USD to EUR, from USD on Mt.Gox to EUR on BitStamp, or from USD to EUR on BitStamp.
Arbitragers can profit by filing offers to do this conversion at a spread. If there is demand in both directions, the arbitrager increases their balance with each transaction.
Intra-gateway Currency Conversion
For people wishing to do cross currency payments between IOUs from the same gateway, there must be liquidity on the ripple network for their payments to succeed.
Profit Opportunity: Provide this liquidity at a spread to make money from cross currency intra-gateway payments.
Inter-gateway Currency Conversion
Gateways as islands
A model of ripple Gateway cash flow:
- Customer deposits cash.
- Customer sends gateway IOUs to someone who accepts it.
- This repeats a number of times.
- Customer withdraws cash.
Notice in this model: IOUs merely trade between users who extend trust to the gateway.
For countries with currency controls, acting as a Ripple gateway may pose no special restrictions as currency does not leave the country, or even the gateway, as IOUs travel.
For people wishing to do cross currency payments between IOUs from the different gateways, there must be liquidity on the Ripple network for their payments to suceed.
Opportunity: provide this liquidity at a spread to make money from inter-gateway payments.
Scaling Cross Currency Arbitrage
The number of possible cross currency pairs on which to provide offers grows as the square of the number of currencies (minus the identical pairs):
- Two currencies:
- BTC → USD
- USD → BTC
- Three currencies:
- BTC → USD
- BTC → EUR
- USD → BTC
- USD → EUR
- EUR → BTC
- EUR → USD
Because each Gateway's currencies are distinct from every other gateway, the number of pairs can quickly become unmanageable.
To scale, instead of bridging each currency/issuer combination, merely bridge currency/issuers to and from XRP.
- Three currencies via XRP:
- BTC → XRP
- USD → XRP
- EUR → XRP
- XRP → BTC
- XRP → USD
- XRP → EUR
Mitigating XRP Currency Risk
To mitigate the XRP currency risk you might:
- Charge a higher spread when converting to and from XRP to offset the risk.
- Provide direct conversion between high volume currency pairs.
- For example:
- bitstampUSD ↔ bitstampBTC
- mtgoxUSD ↔ bitstampBTC
- For example:
Outbound Bitcoin Gateways
Outbound Bitcoin gateways allow ripple wallets to send bitcoins to any address in any currency in the wallet. For this functionality to work, there must be liquidity converting the IOUs in the wallet to IOUs the Gateways will accept. Most outbound Bitcoin Gateways will demand BTC IOUs to avoid currency risk.
Profit Opportunity: provide this liquidity at a spread to make money from outbound Bitcoin Gateway payments.
ripple Offers
This section outlines some of nuances of ripple currency exchange offers.
Taking : Auto bridging
When taking offers between non-XRP currency, ripple will automatically bridge between the two currencies with XRP and take the bridged offer if it is better than any direct offer. Therefore, if you make offers exclusively between non-XRP and XRP you will not be missing out on any direct offers.
Reserves
Each outstanding offer placed requires an additional 5 XRP be held in reserve.
Unfunded offers
Standing offers which are found to be unfunded will automatically be removed from the books.
Expired offers
Offers may have an expiration time. Expired offers are treated as unfunded and are automatically removed from the books.
Cancelling offers
Cancelling an offer costs the standard transaction fee.
Rapidly changing offers
There no point in changing offers more than once per ledger. Transactions against the accounts of other market makers are applied in what amounts to random order.
Inter-gateway Ripple Liquidity
A fee can be charged for transactions which have IOUs ripple through an account. For example, if an account has a trust limit for the same currency with two accounts, IOUs can be traded between balances.
A transaction fee may be charged for rippling through an account.
See:
Authorization Arbitrage
Ripple's Authorized accounts feature allows an issuer to select which accounts may hold their IOUs. For example, an issuer may require KYC or membership fees to hold their IOUs.
An arbitrageur who is authorized to hold the IOUs may make the IOUs available for sale at a profit. For example, placing authorized IOUs for sale allows unauthorized accounts to make payment's to accounts that accepts them.
Cautions
Be wary of trusting more than 1 issuer for each currency for a single account. For example, setting a trust limit of $100 with both Bitstamp and MtGox. In this case, people would be able to use your liquidity to ripple through you between Bitstamp and MtGox. While this will not cost you anything, it may unexpectily change your balances with the the two gateways.
