Crypto arbitrage trading enables you to profit from price discrepancies by purchasing crypto on one exchange where the price is low and selling it right away on another exchange where the price is high.
Arbitrage trading is not a novel idea; it has long been used in the stock, bond, and foreign exchange markets. However, most retail traders are no longer able to participate in arbitrage trading due to the development of quantitative algorithms that can detect price differences and execute trades across several marketplaces.
Nevertheless, there are still arbitrage opportunities in the world of cryptocurrencies, where a sharp increase in trade volume and inefficiencies between exchanges result in price discrepancies.
The pricing of the rest of the market is effectively set by larger exchanges with more liquidity, with smaller exchanges just mirroring the prices set by their bigger competitors. Arbitrage opportunities exist because smaller exchanges don’t always mirror the pricing set on larger exchanges.
What is Crypto Arbitrage trading?
Crypto arbitrage trading is a trading method where investors profit from slight price differences of a digital asset across different markets or exchanges.
Crypto arbitrage trading, in its most basic form, is the practice of purchasing a digital asset on one exchange and selling it (almost) simultaneously on another where the price is greater.
How does Crypto Arbitrage trading work?
In a simplified illustration of cryptocurrency arbitrage, you might look for a particular coin that is less expensive on Exchange A than on Exchange B. Then, after purchasing the coin on Exchange A, you sell it on Exchange B for a higher price and keep the profit.
By doing this, revenues are generated through a procedure with little to no risk. Another fantastic aspect of this approach is that you don’t need to be an experienced trader with a high-end setup to start arbitrage trading.
A simple example of crypto arbitrage trading:
To explain how crypto arbitrage trading works, let’s look at this hypothetical case study.
Take two exchanges into consideration that both list Bitcoin. Let’s name them Exchanges A and B.
The price of BTC is $10,000 on Exchange A, a significant exchange with a considerable trading volume. BTC is valued at $10,015 on Exchange B, a minor exchange with a limited trading volume.
Imagine that the US Internal Revenue Service declares that BTS deposits would not be taxed in any way. This would result in an increase in trading everywhere, but especially in the US. Here, the price differential resulting from the disparity in trading volumes is about $15.
Due to increased demand, the price of BTC on exchange A will rise to $11,140 while it will remain at $11,000 on exchange B. Arbitrage can be used in this situation. The alternative is to buy BTC from Exchange B for $11,000 and then sell it for $11,140 on Exchange A, making a profit of $140 per BTC.
N.B: In this case, we do not take into account the transaction fees, transaction processing times, and potential price changes between the transactions.
Strategies of crypto arbitrage trading
The simplest way to engage in cryptocurrency arbitrage is to carry out all of your transactions manually while keeping an eye out for price disparities in the marketplaces.
Several cryptocurrency arbitrage bots can be found online that are made to make tracking price changes and variations across several exchanges as simple as possible. These “set it and forget it” platforms can provide traders searching for a low-risk, hands-off trading option with a fantastic possibility for passive income.
However, there are several ways crypto arbitrage trading strategies one can employ to profit off of market inefficiencies. Some of them are:
- Cross-exchange arbitrage
- Spatial arbitrage
- Triangular arbitrage
- Decentralized arbitrage
- Statistical arbitrage
Cross-exchange arbitrage
This is the most simple type of arbitrage trading when a trader attempts to make money by purchasing cryptocurrency on one exchange and selling it on another.
Spatial arbitrage
This is another type of cross-exchange arbitrage trading. The only distinction is the location of the exchanges in different regions. The spatial arbitrage strategy, for instance, might be used to profit from the disparity between the supply and demand for bitcoin in America and South Korea.
Triangular arbitrage
This is the practice of transferring money across three or more digital assets on the same exchange to profit from the difference in price between one or two cryptocurrencies.
A trader could, for instance, design a trading loop that begins and finishes with bitcoin. A trader might change bitcoin for ether, then exchange ether for Cardano’s ADA token, and finally change ADA back to bitcoin. In this illustration, the trader switched between three cryptocurrency trading pairs: BTC/ETH, ETH/ADA, and ADA/BTC.
All transactions are carried out on just one exchange. As a result, the trader is spared from having to deposit or withdraw money from different exchanges.
Decentralized arbitrage
This arbitrage strategy is frequent on decentralized exchanges or automated market makers (AMMs), which use automated and decentralized programs known as smart contracts to determine the price of crypto trading pairs.
Arbitrage traders can carry out cross-exchange trades between the decentralized exchange and a centralized exchange if the prices of crypto trading pairs are markedly different from their spot prices on centralized exchanges.
Statistical arbitrage
Statistical arbitrage integrates econometric, statistical, and computational methodologies to conduct arbitrage trades at scale. Traders that employ this strategy frequently rely on statistical models and trading bots to carry out high-frequency arbitrage trades and maximize profit. Trading bots are automated trading tools that quickly and efficiently carry out a large number of deals using pre-established trading strategies.
Why should you consider crypto arbitrage trading?
There are several reasons to consider crypto Arbitrage trading, some of them include
- Low risks
- Fast way to (potentially) turn a profit
- Wide variety of exchanges.
- Crypto markets are still young
- Volatile cryptocurrencies
Low risks
Crypto arbitrage trading carries a bit less risk than other trading tactics because it typically does not require predictive analysis. Arbitrage traders are substantially less exposed to trading risk because they just need to execute trades that last a few minutes at most.
Fast way to (potentially) turn a profit
You have as much time as it takes to perform all the necessary trades to conclude an arbitrage agreement. This presents the opportunity to make gains considerably more quickly when compared to the conventional strategy of purchasing bitcoin, holding it, and then selling it later.
Wide variety of exchanges
There are 391 cryptocurrency exchanges in all. Given the abundance of exchanges, there is a lot of room for price variation.
Crypto markets are still young
Cryptocurrency is still not widely accepted by the general public and the crypto industry is still developing.
Trading in cryptocurrencies is largely unregulated and fragmented, and data is sent slowly across exchanges. In comparison to many major investment markets, there are also fewer traders and less competition, which can all result in possible arbitrage possibilities.
Volatile cryptocurrencies
It’s easy to see how volatile cryptocurrency prices are, and anywhere there’s instability, there’s a chance that exchange prices could vary.
This is a result of shifting supply and demand, as well as significantly because the coin is decentralized. Due to the extreme volatility of cryptocurrencies, there can be significant price variations between exchanges. This creates an opportunity to engage in arbitrage.
What are the risks of crypto arbitrage trading?
Why isn’t everyone engaging in cryptocurrency arbitrage, which in theory should be a very simple trading strategy? Well, every trading strategy has its risks, and to trade profitably, you’ll need to be willing to accept some risks and overcome a few obstacles.
Here are some of the risks and limitations you could face in crypto arbitrage trading
- KYC rules
- Exchanges susceptible to hacks
- Exchange fees
- Requires large trade
- Limit on withdrawal
- Timing
- Slow transactions
- Competition
KYC rules
Know Your Customer (KYC) rules may make it difficult to access many exchanges. For instance, to be able to place trades, you might need to have a bank account in the nation where the exchange is located, or you might need to have your account confirmed (which could take up to 24 hours).
Exchanges susceptible to hacks
You’ll need to hold coins on cryptocurrency exchanges so they’re available for use anytime you need to conduct arbitrage deals. You should be aware of this risk before beginning because there have been numerous instances of exchanges being hacked, not to mention some of them taking money from users.
Exchange fees
Fees on trades and occasionally fees for deposits and/or withdrawals are levied by the majority of cryptocurrency exchanges. These fees must be taken into account when calculating the profitability of a trade.
Requires large trade
Profits from profitable arbitrage deals may be modest if processing hold-ups and all associated expenses are taken into consideration. As a result, to increase your returns, you’ll frequently need to acquire and sell plenty of cryptocurrencies.
Limit on withdrawal
If you want to make large trades, keep in mind that many exchanges have daily withdrawal limits, making it conceivable that you won’t be able to withdraw all the coins you need to complete a successful arbitrage transaction.
Timing
The possibility of the market moving against you or of trade happening before you can carry out your sell trade is another risk associated with arbitrage. Due to the extreme volatility of cryptocurrencies, the price could drastically fluctuate while you are transferring money from one exchange to another.
Slow transactions
Due to the recent increase in trading activity on international cryptocurrency marketplaces, many exchanges have had trouble meeting demand. Delays in withdrawals have occurred frequently, which could be very troublesome if you’re trying to move money as rapidly as possible. The time it takes to complete a transaction can also vary based on the coin you’re sending; for instance, Ether (ETH) transactions are completed far faster than BTC transfers.
Competition
There may be more rivalry for transactions as more traders become aware of the possible benefits of arbitrage.
Tips to keep in mind before getting started with crypto arbitrage trading
Arbitrage has its risks because cryptocurrencies are complex and highly speculative, as we’ve already mentioned. Before you ever try to execute an arbitrage deal, you’ll need to be sure you’re well aware of those hazards.
The following tips should be kept in mind before beginning arbitrage if you have thoroughly investigated how it functions and are aware of the risks.
- Watch out for announcements of a new coin being added to exchange on cryptocurrency forums and news websites.
- When engaging in this form of trading, speed is crucial, so you might want to think about utilizing a coin that supports quicker transfers.
- Create a concise strategic strategy to help you make sure you take advantage of the arbitrage opportunity.
- Make sure you thoroughly investigate any websites or exchanges you intend to interact with in advance.
- Keep an eye on the cryptocurrency markets for any news or developments that can lead to sudden price fluctuations.
- It’s wise to educate yourself on hedging methods and how to apply them to safeguard against unexpected market movements that aren’t in your favor.
- Make sure you trade on a variety of exchanges if you want to make a respectable profit. Additionally, it lessens the danger of putting all of your eggs in one basket.
- Never arbitrage a sum that exceeds your ability to lose. It’s always a smart idea to play it safe because there are so many potential risks that could result in a loss.
Conclusion
Every time there is a market inefficiency, there are several arbitrage opportunities and ways that one can take advantage of.
However, cryptocurrencies are complex, risky, and speculative, and they are also very volatile and sensitive to secondary activity. Before making any decisions, be sure to conduct your research and confirm the details of any coins or exchanges (including their legal status and any applicable regulatory requirements).
