What is Arbitrage in DEXTF and How Do I Do It?
DEXTF Protocol being an oracle-less digital fund management platform relies solely on traders and arbitrageurs to align XTF fund token prices with its net asset value. (You can think of a fund’s net asset value - or NAV - as the cost to mint a new XTF fund token.)
To perform arbitrage generally means to enter into a series of simultaneous buy and sell transactions in one or more markets which result in a profit. One of the simplest forms of arbitrage can present itself when the same asset is trading at different prices in two different markets.
Because the XTF fund tokens trade on Uniswap independently from the tokens that make up the fund, this exact situation can and does arise from time to time. (The “XTF fund token market” can trade at a different price than the price of the sum of all of the fund’s component tokens.)
E.g. At the time of writing, the fund token XTF.000EXC presents an interesting arbitrage opportunity:
You can mint it by supplying the underlying tokens: $BAL, $BNT, $KNC, $LRC, $SNX, $UNI and $ZRX in the respective weights at a cost of $425,97 and sell it immediately on Uniswap at $494,39.
You can refer to this video tutorial on how to perform arbitrage from minting the fund token itself to selling it on Uniswap.
https://docs.dextf.com/documentation/resources/video-tutorials
Here is an arb done on the same fund back in September 2020.
The arbitrage also works - in reverse - when the fund is cheaper on Uniswap (or other DEXes) than its minting cost. In that case, you simply buy the XTF fund token from Uniswap and redeem its components on the dApp. The next step would be to sell the components for a profit since you bought the XTF for a discount to its net asset value.
This is a powerful concept to understand because all of the rebalancing activities in the DEXTF protocol are simply arbitrage opportunities where traders buy and sell tokens to achieve the funds’ allocations that the portfolio managers have predetermined.
In practice there are a few considerations worth keeping in mind when taking advantage of arbitrage opportunities:
Liquidity Risk: Arbitrage might be there for small trades, however when the trade size increases it might disappear or turn into a loss.
Transaction/ Gas Cost: Arbitrage usually takes advantage of small price differences, so the overall transactions cost can quickly become higher than the profit.
Operational/ Timing/ Settlement Risk: By the time you’re ready to buy or sell the price might have moved, possibly even in the middle of your transactions so that one transaction might be completed but another one fails and you cannot complete the arbitrage.
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