Arbitrage band

How it works

The arbitrage band is the price range around spot within which the token trades in equilibrium. It is not a failure indicator, it is an engineered tolerance. The upper bound sits at spot plus the creation fee: any price above that creates a profitable mint-and-sell that participants exploit immediately. The lower bound sits at spot minus the redemption fee: any price below makes buy-and-redeem profitable.

A flat symmetric fee schedule produces a symmetric band that is easy to communicate. Asymmetric fees, where redemption exceeds creation, produce a downward-skewed band that sits below NAV on average. That can suit assets with costly redemption logistics, but it must be disclosed, because holders are structurally buying at a level that will consistently trade below the declared reference price.

How we approach it

The real question is not just how wide to set the band but whether the arbitrage economics at that fee level are viable for real participants. A band that looks tight on paper but whose implied margin falls below realistic round-trip costs, gas, custodian processing, counterparty spread, and capital cost, is a paper peg, not a functioning one. We model the realistic round trip before finalizing the fee schedule, not after.

Liquidity depth interacts with the band for illiquid underlyings. A large sell order can push price through the lower bound, and the correction is not instant: it requires a participant to execute a redemption with its processing delay. During that delay, urgent sellers face prices below the theoretical floor, so illiquid assets often need wider bands to absorb the redemption cycle.

Common mistake

The most frequent error is calibrating the band against the underlying asset's volatility rather than against the cost structure of the participants who enforce it. A low-volatility asset does not automatically support a tight band if the custodian's minimum redemption fee is large. The floor is set by whoever is doing the enforcing.