Crypto Arbitrage

Nov 20th 2020by
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If you've been following the Crypto world closely, you must have noticed there are usually differences in prices between different crypto markets and exchanges. Most people ask how long does it take to mine a Bitcoin? Bitcoin, which is regarded as the most liquid asset, trades at varying prices on different markets.

If you are business-minded, you must have thought these disparities create excellent arbitrage opportunities. However, crypto arbitrage is not as straightforward as it sounds. In this guide, you'll learn how arbitrage works in crypto, the different types, and what to look for in crypto arbitrage. After going through the article, you should be in a position to make informed choices.

What is Crypto Arbitrage?

Crypto arbitrage is the concurrent purchase and sale of a cryptocurrency to profit from a price imbalance. It is a trade in which you take advantage of the differences in prices of the same asset on several cryptocurrency exchanges.

The differences in cryptocurrency prices can be significant across exchanges. These huge disparities present traders with a genuine opportunity to take advantage of inconsistencies in prices. Crypto arbitrage can only exist if markets are not perfect.

Simply put, traders buy low and sell at a higher price. There are several approaches to arbitrage cryptocurrency, all of which are profitable and legitimate. Some are more complex than others, while others require more effort than others.

The main benefits of arbitrage trade are:

  • Quick profits. If all goes as planned, you can increase your capital fast. Also, since speed is essential, you can make money more quickly than with the usual trades.
  • Offers a myriad of opportunities. Traders can access up to 200 exchanges where they can trade cryptocurrencies.
  • Crypto markets are still young and volatile; therefore, most exchanges don't share information. When there are fast rises and drops that create price disparities, traders get arbitrage opportunities.
  • There is minimal competition than in traditional markets. Not many arbitrage traders are ready to try cryptocurrency arbitrage. This makes the cryptocurrency space less competitive.

How Does Crypto Arbitrage Work?

Before delving into how bitcoin arbitrage works, it would be best to understand some of the core elements and terminologies used in cryptocurrency arbitrage.

Order Book

An exchange order book is a fundamental element of asset arbitrage. The order book can be automated or manual and contains a list of current buy and sell orders for an asset. It has four primary terms you should know, i.e., bid, ask, amount, and price.

Regardless of the exchange platform you're using; there will always be two sides of the bid and ask orders. These are used to assess the interest in buy/sell positions of a specific cryptocurrency. Bids show buy orders - how much a trader wants to buy and the price they are willing to pay. The ask side shows the sell orders.

Fiat

Also known as fiat money is the usual government-issued and maintained money—the money you use to pay for goods and services, for example, Euro.

Crypto Asset

This digital asset is created as an open and decentralized means of payments recorded in the blockchain. Examples include cryptocurrency, platform tokens, utility tokens, and transactional tokens.

Volatility

Volatility refers to the degree of price fluctuations. High volatility is when huge market fluctuations occur because of unexpected events. Low volatility refers to minimal changes in price because of poor demand.

Deposit

This is the amount of money you are willing to invest in your account to buy security.

Withdrawal

This refers to the amount of money you can take from your account after you have successfully traded.

How it works

Here is a step-by-step guide to arbitrage trading

  1. Look for a cryptocurrency that is traded on more than one exchange. Even though you can do arbitrage on a single exchange, it is advisable to consider two different exchanges.
  2. Collect the books from the two platforms and evaluate the traders' interest.
  3. Compare arbitrage opportunities on both exchanges to look for a perfect correlation between them.
  4. Buy the asset on the exchange with the lowest price.
  5. Withdraw the crypto asset to the other exchange.
  6. Sell the cryptocurrency on the second exchange.
  7. Continue buying and selling until your chosen correlation ends.

What Are The Different Types of Arbitrage?

There are two main types of crypto arbitrage: regular or simple arbitrage and triangular arbitrage. There is also the statistical arbitrage, which is regarded as more complex.

Simple Arbitrage

Simple crypto arbitrage involves buying and selling the same crypto asset on different exchanges as fast as possible to take advantage of the inefficiencies in pricing across exchanges. In this form of arbitrage activity, you'll not need any extra trades apart from those required to swap the two assets shared by the asset pair showing the arbitrage opportunity.

The trader will make money from the price difference of the same cryptocurrency but on different exchanges. However, you will have to pay trading and withdrawal fees. The fees can range from 3% to 15% of your crypto asset price, depending on the exchange you use.

You might have to wait for up to five days for the transfer between the two exchanges to be completed. Because the cryptocurrencies are highly volatile, the theoretical profit might reduce or increase during the waiting period.

You can reduce the number of fees and waiting time if you deposit both crypto and fiat currency on both exchanges you'll use for arbitrage opportunities. This way, there'll be no transfer of cryptocurrencies between the exchanges, meaning you'll reduce the waiting time. But you'll have to pay withdrawal fees when you decide to take your profits.

Pros:

  • It is simpler to perform than other forms of arbitraging cryptocurrencies.
  • Traders don't need to have extensive cryptocurrency knowledge to make a successful trade.
  • You can get your profits immediately if you don't trade between exchanges.
  • There are no transfer fees or time for trade activity on the same exchange.
  • It is easier to discover arbitrage opportunities.

Cons:

  • Takes a longer time (up to five days) for the two exchanges to be completed.
  • The transfers are costly.
  • Traders might lose the profit margin during the waiting period.

Triangular Arbitrage

A triangular arbitrage happens on one exchange or across several exchanges where the price differences between three different cryptocurrencies provide an arbitrage opportunity. Many exchanges usually have several markets with various quote currency options. This creates a long list of triangular trading patterns in which you can take advantage of price differences in a single exchange pricing.

In simpler terms, it involves trading the first currency into the second one and then trade the second one into a third currency. Finally, you trade the third currency into the first one.

Follow the steps outlined below to perform triangular arbitrage trading:

  1. Look for three assets that you can arbitrage easily.
  2. Select the cryptocurrency that you want to remain with.
  3. Trade into a second crypto asset. This asset should have a connection to the first and third assets.
  4. Trade the second cryptocurrency into the third you chose.
  5. Finally, exchange the third currency into the first one.

Pros:

  • Traders get a risk-free profit the moment the second trade is completed.
  • Presents traders with a fast way to make a profit while trading in an unstable market.
  • You can perform it on a single exchange.
  • Trading does not attract any transfer fees.
  • It does not take long to be completed.

Cons:

  • It requires large capital as you have to trade with three cryptocurrencies.
  • It is rare and not easy to perform.
  • It is also more challenging to discover.

Statistical Arbitrage

This type of cryptocurrency arbitrage applies a more analytical approach to trading. To be successful in this approach, you must have great mathematical calculations and exceptional analytical capability. In many instances, traders prefer to use bots to perform all the necessary calculations.

You'll open long and short positions simultaneously to help take advantage of inefficient prices in correlated assets. Since the trading is based on previous price meanings, it provides a degree of risk. Mostly, it uses mean - reversion models.

Pros:

  • It is market neutral.
  • There are higher chances of making profits.
  • You can use bots to help do complex mathematical calculations.

Cons:

  • It depends on historical price averages to make future predictions making the risk higher.

What to Look For With Crypto Arbitrage?

There are factors traders must consider to be in a position to identify great crypto arbitrage opportunities between exchanges. Some of the elements you must consider include:

  • Liquidity - you should look at the difference in trading volumes on different exchanges. This is because of the difference in supply and demand influences the prices. More established exchanges usually have more stable prices than smaller or newer exchanges.
  • Geography - depending on your time zone, it might be challenging or more comfortable to sell at certain times of the day.
  • Listings - this refers to the difference when a Bitcoin is listed on one of the leading exchanges.
  • Reputation - You should check out what other users are saying in their reviews about an exchange before creating exchange accounts. This will help you to avoid troublesome exchanges
  • Transaction times - some blockchains allow for fast transactions, while others take up to an hour or more.
  • Withdrawal times - understand the withdrawal rules of the exchange before joining.
  • Account verification - some exchanges must verify traders' accounts before they can withdraw and use the markets. The process might take various days or weeks.
  • Wallet Maintenance - Many arbitrate opportunities happen because of wallet maintenance in specific exchanges. Ensure you know whether you can transact the crypto asset of your choice.
  • Fees - high or low trading, deposit and withdrawal charges are the deal-breakers. It is advisable to choose exchanges with as low fees as possible.

FAQ's

Is crypto arbitrage legal?

To arbitrage, cryptocurrency is legal. The main idea is for a trader to buy and sell crypto assets like in any other security in a market. Some exchanges reserve the right to limit your transactions or freeze your deposits if they suspect you are using tools to leverage trades in your favor.

Is crypto arbitrage profitable?

Yes, when you arbitrate Bitcoin or any other cryptocurrency, you'll make a profit. But, the amount you make is dependent on the opportunities you find on the exchanges. Furthermore, the development of cryptocurrencies worldwide resulted in a more stable market making the exchanges more reliable.

Is crypto arbitrage legit?

Cryptocurrency arbitrage is a legitimate business venture. It is not a scam, as believed by many. To arbitrage, Bitcoin is an honest and long-established way to trade stocks, commodities, and crypto assets to make profits.

How do you make money with crypto arbitrage?

To make money on arbitrage using cryptocurrencies, you must first identify an arbitrage opportunity. These opportunities occur within an exchange or between exchanges. Then, decide whether you'll buy or not. Your profits are determined by the price differences of the assets you choose to trade on.

Conclusion

If you are interested in making profits in the cryptocurrency market, you should consider crypto arbitrage. It is legal, and bots and software will make your trading much more effortless. It would be best if you selected an arbitrage approach that you're comfortable with. If you have a strategy, ensure your choice is in line with it.