You have been hired by a well funded hedge fund to assess whether there are any arbitrage opportunities created by differences in prices in bitcoin across different markets. For the purposes of this exercise, you may ignore transaction costs by using the midpoint between the highest bid price and the lowest ask price as the price on the exchange. (In fact, most of the time the difference between these two prices is very small, but if you want to make this case more realistic, then we suggest reading Arbitrage with Transaction Costs in the appendix of this chapter, and then using the ask price when you purchase and the bid price when you sell.)

Begin by checking the current price of bitcoin on Coinbase, a U.S. based exchange. (To find the quotes, go to https://pro.coinbase.com, click “View Exchange” on the top of the screen. The prices are in US$ with bid quotes shown in green and ask quotes shown in orange.)

Then compare this price to the price of bitcoin on Bitstamp, another U.S. based exchange. (To find the quotes, go to https://www.bitstamp.net and click on “Tradeview” in the top right-hand corner.)

Are the prices the same? If not, how much money can you make if you trade $1000 and what trades would you execute? How large would the transactions costs have to be to wipe out this profit?

Express your answer as a percentage of the amount you trade.

Now look up the price of bitcoin on bithumb, a Korean based exchange. (To find the quotes, go to https://www.bithumb.com/tradeview or from https://www.bithumb.com, pick Exchange, Bitcoin, chart trade.) These quotes are in Korean Won, so you will need to convert them into U.S.

dollars. Find the current exchange rate by searching for “USD KRW quote.”

How do the prices of bitcoin on bithumb compare to the prices of bitcoin on Coinbase? Are any deviations smaller or larger than any deviations you observed when you compared Bitstamp to Coinbase? How much money can you make if you trade $1000 and what trades would you execute?

How large would the transactions costs have to be to wipe out this profit? Express your answer as a percentage of the amount you trade.

What frictions might explain your results? That is, in a frictionless market, deviations between prices of the same asset on different exchanges present a profit opportunity that we would expect traders to take advantage of and thereby eliminate. For such opportunities to persist, one would expect the existence of frictions that prevent traders from easily taking advantage of the deviations in prices.