You’re spotting your workout partner as his quivering arms place the barbell back on the rack, “how do mergers work?”, he gasped. Interrupting you, he inquires, “how does 3 way arbitrage work?” Eyes skyward and hoisting the resting weights as you lie on the flat bench, this is what you tell him…
How Does 3 Way Arbitrage Work?
A 3 way arbitrage works by capitalizing on the price differences of three different currencies to realize a profit. The strategy is known as triangular arbitrage, and it exploits exchange rate discrepancies among three currencies through a circular trade execution to generate profit with no net investment. A no net investment means the investor does not need to infuse additional capital beyond her initial investment to complete the three-cycle trade. The proceeds from each trade fund the next trade ideally ending the three-way execution with more capital than the original investment i.e. a profit.
Properly addressing the question, how does 3 way arbitrage work? Requires a detailed breakdown, in which the no net investment concept is highlighted:
Initial Investment Capital – Our arbitrageur begins with US dollars (currency).
Triangular Trade Sequence
1. She converts her initial US currency into EUR (Euros).
2. She takes her EUR and converts it to GBP (British Pound Sterling)
3. To complete the 3 way arbitrage, she converts her GBP back to US dollars.
Organic Funding Process - Each conversion funds the next trade without the use of additional capital to complete the trade cycle, hence a no net investment.
Realized Profit – The injection of additional funds is not the profit source; it is the discrepancies in the exchange rates. A successful triangular arbitrage will result in the final proceeds generated from the last conversion to US currency which is greater than the US dollar initial investment.
How does 3 way arbitrage work? A 3 way arbitrage takes advantage of the exchange rate price discrepancies of three different currencies through a circular trade execution.
What is an Example of a 3 Way Arbitrage?
1. Begin with $1,000 US
2. Convert US to EUR
$1,000 US X 0.75 (conversion rate) = 750 EUR
No additional capital needed
3. Convert EUR to GBP
750 EUR X 1.32 (conversion rate) = 990 GBP
No additional capital needed
4. Convert GBP back to US
990 GBP X 1.43 (conversion rate) = $1,415.70 US
Again, no additional capital required
3 Way Arbitrage Profit
$1,415.70 (total arbitrage proceeds) - $1,000 (initial arbitrage investment) = $415.70 Gross Profit
The allure of this strategy is being able to generate a 41.57% or greater return usually within milliseconds, worst case, a second or two.
How does 3 way arbitrage work? Triangular arbitrage seeks to profit from the price discrepancies of currency exchange rates. The strategy’s major benefits are no additional funds outside of an investor’s initial investment are required to generate a profit and successful trade profits can be realized within seconds. As with all investing, risk is ever-present, and the risk/reward profile should be assessed prior to making any capital investment.
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