Arbitrage Loop

An arbitrage loop is a trading strategy that exploits price differences for the same asset across different markets or between a derivative and its underlying asset. In the context of stablecoins, the loop involves minting or redeeming tokens to profit from deviations from the peg.

If a stablecoin trades at a premium, an arbitrageur can buy the underlying collateral at the peg value and mint new tokens, selling them at the higher market price to lock in the difference. Conversely, if it trades at a discount, they can buy the tokens cheaply and redeem them for the underlying assets at full value.

This activity is crucial for the market, as it constantly pulls the asset price back toward its target. The existence of an efficient arbitrage loop is a key indicator of a healthy and stable financial instrument.

Without it, the asset would be prone to persistent price instability and lack of utility as a medium of exchange.