> Now with short selling it looks like you can instantly borrow a bitcoin on the exchange that's inflated, then sell it immediately
This sounds more like speculation than arbitrate. With arbitrage, you transfer liquidity from one exchange to another by having a short leg on the higher-price exchange and a long leg on the lower price one. This is great for Bitcoin because it evens out the price differences between the exchanges, and at the same time transfers the liquidity of one exchange to another one, while the arbitrageur makes a profit.
I don't see how leveraged trading can replace this. Arbitrate is, essentially, taking orders from one exchange and selling them on another one, thereby matching a buyer and a seller on separate exchanges. It's a genuine service to the market.
Leverage does the same because the counter-party wouldn't be able to tell the difference on whether you used your own or borrowed bitcoin and hence the effect is the same.
I see your point now. I guess it all comes down to whether the arbitrageur is willing to take the risk of not being able to cash out bitcoins on the leveraged exchange. Leverage certainly increases the risk of not being able to withdraw, and often when you need it the most.
This sounds more like speculation than arbitrate. With arbitrage, you transfer liquidity from one exchange to another by having a short leg on the higher-price exchange and a long leg on the lower price one. This is great for Bitcoin because it evens out the price differences between the exchanges, and at the same time transfers the liquidity of one exchange to another one, while the arbitrageur makes a profit.
I don't see how leveraged trading can replace this. Arbitrate is, essentially, taking orders from one exchange and selling them on another one, thereby matching a buyer and a seller on separate exchanges. It's a genuine service to the market.