The current crypto world is still fragmented. The abundance of platforms and liquidity pools and a lack of seamless connections constantly supply users with many arbitrage opportunities.
Dubai, UAE, 9th December 2023, By enhancing bots and creating more complex trading strategies, arbitrageurs have been able to open a new area for trading — cross-domain. So, what is it exactly? Let’s take a closer look.
Cross-domain Arbitrage & MEV
Cross-domain arbitrage involves exploiting price differences for the same asset across different domains, which may include blockchains, layer-2 networks, side-chains, centralized exchanges, and any other entities with relatively separated liquidity. This type of trading overlaps with cross-exchange and cross-chain arbitrages that take advantage of price differences between different exchanges and chains, allowing for greater flexibility than standard trading.
Cross-domain arbitrage is often linked with MEV, which enables traders to enhance their profits by creating more intricate trading strategies. MEV, which stands for Maximum Extractable Value, has a significant impact on the security and impartiality of blockchain networks. It is made feasible by the existence of mempools, where transactions wait to be verified and confirmed. Since mempools are public and the order of transaction validation is not predetermined, traders can scrutinize transactions and use strategically placed orders to gain profits.
Arbitrageurs look for transactions that can impact the price of particular assets, opening opportunities for arbitrage trading across platforms. They place their trades before, after, and on both sides of a target transaction to take advantage of possible price movements, thus engaging in so-called MEV attacks.
For instance, such an MEV attack as back-running involves placing a transaction immediately after the target transaction. This way, a trader can take advantage of price fluctuations caused by the target transaction and increase profits by trading across domains. This MEV tactic is relatively harmless because it does not cause any harm to the target transaction and the user who placed it. However, front-running, sandwiching, and suppression are other types of MEV tactics that can seriously affect the execution of user orders and their cost-effectiveness. Nevertheless, these tactics are widely used by traders, who also employ bots to automate and optimize their strategies for maximum profit and flash loans to find extra liquidity.
Making a substantial profit through cross-domain arbitrage is possible, but it entails numerous challenges and risks. One of the most significant obstacles is the absence of cross-chain atomicity, which severely restricts the potential for cross-domain arbitrage. Cross-chain atomicity refers to the capability to execute a transaction that involves multiple blockchain networks without intermediaries and in a way that guarantees the full completion or cancellation of the transaction. This aspect is critical for the efficient execution of cross-domain arbitrage.
Moreover, transferring assets between different domains can be time-consuming and expensive, presenting another challenge traders should be mindful of. Such costs can seriously impact their margins, and even using bots can only partially prevent mistakes.
Lastly, arbitrage bots are critical in the crypto market as they exceed humans’ abilities to find opportunities, analyze market conditions, and rapidly execute trades. However, operating bots is a complex task that requires understanding the technical side and having a good grasp of how the crypto market works. Over-reliance on bots can lead to substantial losses, so it is essential for arbitrageurs to carefully evaluate the potential risks before participating.
Cross-domain arbitrage trading opens up a whole new area of potential profit but also requires creating new, more advanced solutions. Although such solutions (for instance, decentralized multi-chain block production) are being explored by researchers and developers, achieving cross-chain atomicity remains a lofty goal for current traders. Nevertheless, there is optimism that it will become more attainable in the near future.