Cryptocurrency arbitrage is buying a cryptocurrency for a low price on one market and selling the same cryptocurrency on a different market for a higher price. Cryptocurrency arbitrage allows traders to make profits quicker than with regular trades.
What is a Cryptocurrency Arbitrage?
For an overview of cryptocurrency arbitrage, here’s what you need to know:
- Cryptocurrency arbitrage entices traders because, compared to traditional markets, the competition is sparse.
- Cryptocurrency markets are still relatively new, with assets rising quickly and dropping suddenly.
- Arbitrage is the buying and selling of an asset that turns a profit by exploiting price differences between markets.
- Arbitrage ensures that market prices do not deviate from fair value for too long.
There is more space because not every arbitrage trader is interested in crypto. This leads to price gaps that give traders opportunities for profitable arbitrage. Market inefficiencies, which means the value of an asset is not accurately reflected by its price, allows arbitrage to exist.
Arbitrage is considered a risk-free profit for traders because it involves purchasing an asset in one market and selling it at a higher price in another market. Crypto traders can succeed using arbitrage if they analyze the patterns of price charts and make immediate trades. The market fluctuates quickly, and traders need to know how to predict movements.
Types of Crypto Arbitrage?
The rate of crypto arbitrage is set by buyers and sellers who are willing to pay for cryptocurrency. They calculate the overlap between the lowest ask prices and the highest bid prices. There is an opportunity for arbitrage when the bid price on an exchange for a cryptocurrency is higher than the asking price on another exchange.
Crypto arbitrage is similar to regular stock arbitrage in that it involves buying at a low price and selling at a higher price. However, crypto arbitrage is different from regular stock arbitrage in that it’s faster and more low-risk than regular stock investing and trading.
Crypto-Crypto vs. Crypto-Fiat
Cryptocurrency and fiat currency are both forms of currency that can be traded or used to purchase goods and services, but they differ in a few ways.
Crypto-Crypto, or cryptocurrency, is not backed by a bank or government and is therefore not considered legal tender. Cryptocurrency cannot be used to pay taxes, but you do have to pay taxes on it. The supply of cryptocurrency is controlled by an algorithm.
Crypto-Fiat is backed by a bank or government and is considered legal tender, taking the form of bank credit or physical dollars. Fiat currency can be used to pay taxes, and its supply is controlled by the government.
Arbitrage Between Exchanges
Arbitrage between exchanges is also referred to as Triangular Arbitrage. Arbitrage between exchanges happens when there are price differences between three different cryptocurrencies.
Arbitrage between exchanges is not the best way to turn a profit because transfers are slow, and price differences, or spreads, do not exist for very long. By the time you’ve transferred crypto from one exchange to another, prices will have changed.
Arbitrage Within a Single Exchange
Arbitrage within a single exchange involves traders purchasing two different cryptocurrencies from the same exchange and selling them when there’s a price difference.
Arbitrage within a single exchange is also known as spatial arbitrage and allows you to transfer crypto without transferring between exchanges. With arbitrage within a single exchange, you are able to submit a buy and sell order for two exchanges while holding a balance for both.
Strategies & Methods of Crypto Arbitrage?
You can utilize crypto arbitrage in a few different strategies and methods, so it’s important to know the difference between them.
- The process of buying and selling an asset simultaneously.
- Investors profit off the difference in prices.
Cross Border Arbitrage
- Triangular arbitrage that offers differences in prices of three exchanges.
- Arbitrage in two exchanges in different countries.
- Arbitrage across borders of different countries; may result in price differences.
- Uses mathematical modeling.
- Identifying opportunities for arbitrage using mathematical models.
- Bots can trade hundreds of cryptocurrencies at once.
- Opportunity for arbitrage that uses variations in the price of foreign currencies at three different exchanges.
- Trades difference between three different cryptocurrencies on one exchange.
- Uses platforms or robots to save traders’ time by analyzing trading signals and executing trades.
- More accurate if settings are correct; probably best for traders who are familiar with coding.
How Does A Cryptocurrency Arbitrage Work?
Cryptocurrency arbitrage works in the real world like other types of trading in that some of the trading volumes in an exchange are minimal and the cryptocurrency prices may be high, while in some larger exchanges, prices of cryptocurrency may be lower, and trading volumes may be high.
Cryptocurrency arbitrage is a common practice for a crypto investor. Some people have arbitrage from buying cryptocurrency on smaller exchanges and then selling it on larger ones. One core element of cryptocurrency arbitrage is an exchange order book.
An order book is a ledger, manual, or automated list of current sell and buy orders, or ask and bid, respectively. The number of units to be traded are shown by amount and price. Fluctuations in cryptocurrencies lead to opportunity by allowing traders to sell crypto, sometimes at significantly higher rates than they purchased it for.
How to Calculate Arbitrage Opportunity? What Is The Catch?
Arbitrage Opportunity is based on the number of participants who are willing to buy and sell on an exchange and also the supply and demand of a product. Unlike other profit-making opportunities, arbitrage opportunities may be more irregular.
- Arbitrage opportunity comes from the guarantee of liquidity. Liquidity comes from continuous participation of a bid-ask spread to the exchange market.
- Prices are affected by supply and demand.
- Arbitrage opportunities can arise by taking advantage of price differences between locations. For example, taxes and fees may be lower in some locations than in others.
- Prices fluctuate quickly and across time zones. So maybe prices go up while someone in the US is still sleeping and someone else in France is able to take advantage of the opportunity.
- Buying and selling from listings are one of the main forms of an arbitrage opportunity. It may not result in big money but can still turn a profit.
An arbitrage opportunity is relatively low risk but may also be low profit with today’s modern technology. As the market becomes more technologically advanced, price discrepancies are detected and corrected almost instantaneously, before people can even buy and sell cryptocurrency.
Another catch is that you usually have to invest heavily to be able to gain any sort of profit. You also have to be aware of foreign exchanges and transaction costs. Still, arbitrage opportunities are here to stay because risks between currencies and countries are forever present and ever-shifting.
Steps to Performing Arbitrage
There are five steps to successfully investing in cryptocurrency arbitrage, all of which are listed below.
- Fund Exchange Accounts: Traders should look for cryptocurrency that is traded on at least two, if not more, exchanges.
- Identify Opportunities: Traders should set up order books from all exchanges to gauge the interest of other traders.
- Quantify Opportunities: Traders should compare opportunities on all exchanges.
- Execute the Strategy: Traders should buy the lowest priced cryptocurrency, withdraw the cryptocurrency to the second exchange, and then sell it.
- Repeat the Process: Traders should continue the process until they are no longer turning a profit.
How to Select Exchanges for Crypto Arbitrage?
Before choosing exchanges, there are eight different deciding factors you should weigh in on before settling on your crypto arbitrage of choice.
Exchanges have three major fees you may have to take into consideration when choosing cryptocurrency arbitrage. The first is taken for withdrawing and depositing money from your credit card or bank account.
The second is any transaction fee that may arise depending on the exchange. The third fee is for the withdrawal and deposit of cryptocurrency if an exchange has to create a new address.
There are different platforms in different areas that allow traders to exchange on crypto arbitrage. The volume of traders and exchanges may decrease the arbitrage opportunities.
Household names are not always the best exchanges. Some exchanges may have slower reaction times, especially if they’re well known. However, new cryptocurrency listings may not be the best investment, given that there’s probably little demand for it as a new listing.
Transaction times can be slow, depending on the market. Sometimes you will try to make a trade, and in the time it takes your transaction to go through, the market may shift, and you might lose the window for profit.
Traders must be mindful that some exchanges have specific withdrawal limits. You don’t want to reach your limit when you still have a crypto balance in your wallet and miss the opportunity to sell it while the price is high.
Sometimes identification restrictions will call for people to have bank accounts in the country an exchange is based in.
The more people there are exchanging cryptocurrency, the less opportunity for arbitrage there is.
It’s recommended that in order to turn a profit on cryptocurrency, you should trade quickly, or not at all. As previously mentioned, the market changes quickly.
Is Crypto Arbitrage Profitable?
Like other investment ventures, with crypto arbitrage, you get out what you put in. In theory, the more time and money you invest in crypto arbitrage, the more profit you should earn. So long as you are equipped with the proper tools and knowledge, you should see a profit.
With today’s advanced technology, traders are able to access multiple listings at once and buy and sell cryptocurrency quicker. Traders may even set up bots that can work for the arbitrage for them.
Is Crypto Arbitrage Legal?
Crypto arbitrage is completely legal in most places, although the language used to describe cryptocurrency varies around the world. Cryptocurrency may also be referred to as virtual commodity, cyber currency, crypto-token, virtual asset, electronic currency, payment token, or digital currency.
Most governments warn about the use of crypto arbitrage due to its being unregulated and not backed by any form of bank. There is no legal recourse available to citizens if their investment in cryptocurrency is lost, and those who do invest do so at their own personal risk.
Some countries, including Canada and Australia, have even changed their laws to include cryptocurrency under the category of money laundering, given that cryptocurrencies may create opportunities for illegal activities. Other countries, like Vietnam and Pakistan, have banned cryptocurrency activity entirely.
Conclusion—Is Arbitrage The Way to Go?
As with any kind of exchange, the chance to make a profit from crypto arbitrage depends on the market. Depending on barriers put into place surrounding the use of cryptocurrency and the number of traders buying and selling, the market goes down.
However, there is a growing market for cryptocurrency, and crypto arbitrage allows investors the chance to turn high profits and fast.