What Is Crypto Arbitrage and How Does It Work?

In the past decade, cryptocurrencies have made a noticeable mark on human society. Some tout it as the currency of the future that can fully replace national currencies. Many others have jumped onto the cryptocurrency trading bandwagon, using it as an alternative to stock market trading. Yet others have started using a crypto arbitrage to maximize their returns. However, as with any kind of cryptocurrency trading, crypto arbitrages possess a lot of risks. In this article, we show you what you need to know about crypto arbitrages.

Before you jump into crypto arbitrage opportunities offered by your friends, it’s important to know what it is. Simply put, a crypto arbitrage involves taking advantage of the differing prices for the same cryptocurrency across different exchanges. Traders use the low price of one exchange and the high price of the other. They buy low and sell high—much like trading—to profit from the difference.

The reason this is possible is that there are already over 1,000 cryptocurrency exchanges currently operating. Binance, Coinbase, and Kraken are all well-known examples of different cryptocurrency exchanges. However, a crypto arbitrage specifically works because these different exchanges offer different prices for the same cryptocurrency.

For example, one Bitcoin may be priced at $30,000 on Binance. However, over at Coinbase, one Bitcoin could cost around $30,050. That $50 difference is what the traders track to gain a profit. They’ll buy one Bitcoin on Binance and sell it on Coinbase, earning an easy $50. 

However, the key to it, in this case, is timing. That’s because cryptocurrency markets are extremely volatile. They change prices in seconds, so traders need to be quick on their toes. Otherwise, they may end up losing money instead of earning them, making crypto arbitrage a risky business.

In concept, this trading works similarly to any other financial arbitrage. This kind of potential earning mechanic exists in stocks, bonds, and traders with foreign markets. They buy one item in one market and sell it in another at a higher price. In some sense, it’s similar to buy-and-sell business models, only it works with currency.

Now, you may be thinking that all this sounds too good to be true. Is it truly that easy to profit without doing much except for buying and selling cryptocurrencies? How exactly does it work? Well, it works simply because there are many inefficiencies within various crypto exchanges. 

For example, sometimes there are large, quick increases or decreases in crypto trading that the traders can exploit. Moreover, certain smaller crypto exchanges only follow larger exchanges in the way it sets crypto prices. However, there’s a delay when they do this, making that sliver of time easy to leverage.

Conversely, traders might also utilize their knowledge of the cryptocurrency market to time arbitrage correctly. However, this requires a lot more research into the way the cryptocurrency market works and how prices rise and fall. With that said, let’s take a brief look at cryptocurrency pricing. 

If you want to further understand why crypto arbitrage works, you have to know how exchanges price cryptocurrencies. Unlike fiat money, cryptocurrency doesn’t back its value on precious metals. Instead, its price is mostly based on perceived value.

In theory, a cryptocurrency’s worth is determined somewhat arbitrarily. On one end, cryptocurrency prices are purely theoretically assigned. However, people also argue that the price others are willing to pay for cryptocurrencies sets its value. Once the perception of cryptocurrencies drops, their value also drops. In reality, cryptocurrency prices are likely a mix of both of these theories.

In practice, crypto exchanges price cryptocurrencies based on the latest trade price. If the latest trade for Bitcoin pushes through at $30,000, then $30,000 is Bitcoin’s current price. Of course, if you don’t know what trades are, they’re the buying and selling of crypto at a set price.

For example, let’s say a trader wants to buy Bitcoin at ,100. To complete this trade, a seller would have to sell Bitcoin at the same price — $30,100. In this way, the trade is fulfilled and a new price for Bitcoin is set. Prices change so long as these trades keep happening. 

Of course, not all crypto exchanges price their cryptocurrencies this way. Some smaller crypto exchanges only follow the pricing of larger exchanges to stay competitive. However, like we previously mentioned, there’s a delay when smaller crypto exchanges do this. Hence, some traders use this knowledge to their advantage.

Types Of Crypto Arbitrage

Now that you know how exchanges price cryptocurrencies, let’s take a look at the different types of crypto arbitrage. There are two main categories: crypto arbitrage between exchanges (also known as triangular arbitrage) and crypto arbitrage within exchanges.

Crypto Arbitrage Between Exchanges

Much of what we already discussed deals with crypto arbitrage between exchanges. To reiterate, it requires using two different crypto exchanges. One could be Binance, while the other, Coinbase. Traders could buy Bitcoin at a low price on Binance and sell it high on Coinbase.

However, there are different methods even within crypto arbitrage between exchanges. Firstly, you could complete your arbitration by transferring currency from one exchange to another. However, this method is both inefficient and costly as transfers usually have costs. Moreover, crypto prices change in just a few seconds, making arbiters easily miss their opportunities. Since transfers usually take time, sometimes up to minutes, it isn’t ideal for something as volatile as cryptocurrencies.

Traders can get around this by buying the same currency on both crypto exchanges. They then hold the money on both exchanges and wait for the right moment. Once the crypto price is ideal on both websites, the trader can immediately conduct transactions in both. 

For example, Bitcoin might be priced at $30,100 on Coinbase while it is only $30,000 on Binance. The trader can easily buy 1 Binance Bitcoin and immediately sell their Bitcoin on Coinbase. They then gain a $100 profit from the transaction without needing to transfer funds.

Lastly, traders can also conduct crypto arbitrage between exchanges through triangular arbitrage. This works similarly to this type, but instead of utilizing two, they use three different exchanges. The trader then utilizes the price difference across the three platforms to profit off the difference.

Crypto Arbitrage Within Exchanges

As opposed to crypto arbitrage between exchanges, crypto arbiters may conduct arbitration within one exchange. For example, they can do this by purchasing two different cryptocurrencies from Coinbase. Arbiters can then wait until there’s a price difference from where they can gain a profit. This eliminates the need for both transfers and monitoring prices on two different exchanges.

Crypto Arbitrage: Disadvantages & Risks

Like other kinds of arbitration and trading, there are numerous disadvantages and risks in crypto arbitrage. Here are just some of the reasons why you might want to reconsider becoming a crypto arbitrage trader.

Coin Storage

One of the most obvious disadvantages to crypto arbitrage is coin storage. You need to store coins across all crypto exchanges if you plan on doing it between exchanges. While this may not seem risky, online coin storage accounts always come with the risk of compromise. 

This means that bad actors could hack your accounts and steal your coins from you. Moreover, smaller and lesser-known exchanges could scam and steal coins from traders. There are many websites out there that promise high returns with little-to-no backing, such as Crypto Arbitrage VIP. Hence, you’ll need to carefully evaluate which exchanges to transact with.

Fees

Crypto exchanges also need a way to earn money, and one of the ways is through fees. There are fees for withdrawing, depositing, and trading cryptocurrency. Crypto arbitrage traders need to consider these fees before conducting a trade.

Large Profit Requires Larger Trades

If you make something like $1 on an arbitration, is it truly worth it? Many folks want to earn more than a couple of dollars on a crypto arbitrage. Hence, larger investments on an arbitrage will reap larger rewards. Unfortunately, if your ideal prices suddenly change before you complete the trade, you might end up with a huge loss. In addition, large trades require lots of money that not every trader might have to spare.

Timing & Transaction Delays

In crypto arbitrage, timing is the key to making a trade worthwhile. That’s because if you miss the timing, you might end up with a loss. However, it’s not easy to time crypto arbitrage correctly because transactions can take up to ten minutes or more to push through. In that time, the market could shift and prices change, making you lose the opportunity. 

Moreover, since the international cryptocurrency markets have grown, it now takes a longer time to process transactions. This is especially true for more popular and widely traded cryptocurrencies. For example, if you’re trading in Bitcoin, it may take longer to process than trading Ethereum. 

Restrictions & Regulations

Some crypto arbitrage traders want to trade across different countries. That’s because prices can also vary depending on which country you’re in. Hence, trading internationally may yield higher profits for traders.

Unfortunately, this potential benefit also comes with a lot of restrictions. That’s because traders always need to comply with KYC regulations before engaging in cryptocurrency exchanges. Some regulations also require traders to have bank accounts based on the exchange’s country. Also, regulators can take time (up to 24 hours) to verify accounts before allowing them to trade. All of these things can be obstacles if you’re looking to conduct crypto arbitrage internationally. 

Advancements In Technology

When crypto trading was just starting, cryptocurrency trades were conducted manually. However, technology has greatly advanced since then. Hence, most exchanges and trades are now computerized, eliminating a large margin of error between prices. Due to this, crypto arbitrage traders have fewer exploitation opportunities.

Summary & Conclusion: Crypto Arbitrage

Crypto arbitrage is one of the opportunities for profit that resulted from the rise of cryptocurrency trading. It’s a way to leverage the inefficiencies of various cryptocurrency exchanges and price differences. Crypto arbitrage traders can do this by trading one cryptocurrency for another across different exchanges with different prices. On the other hand, they could also do this within one exchange using two different cryptocurrencies.

It’s similar to how currency exchange booths profit from trading different national currencies. However, crypto arbitrage deals entirely with cryptocurrencies and crypto exchanges. It’s done entirely on digital platforms with digital trades. 

Unfortunately, while crypto arbitrage offers a large profit potential, it can be very risky and tricky to conduct. That’s because crypto arbitrage relies entirely on prices set by different exchanges. These prices are volatile because of the very nature of the cryptocurrency market. Moreover, there are numerous fees associated with crypto arbitrage, along with regulations and restrictions.

Hence, crypto arbitrage traders need to be quick if they don’t want to lose profit. They also need to learn how cryptocurrency markets work and reliably predict prices just like traders. It’s certainly a profitable endeavor, but one that requires a lot of research and hard work.