Cryptocurrency Arbitrage Guide: All You Need To Know

Cryptocurrency Arbitrage Guide: Everything You Need To Know

Crypto arbitrage trading has become a worldwide phenomenon that has made many people wealthy. But what exactly is it?

While the term “arbitrage” sounds like something only a Wall Street wizard can understand, it is quite easy to grasp. It is simply the simultaneous buying and selling of an asset while taking advantage of the difference in pricing of it on two or more markets. Crypto arbitrage is the buying of cryptocurrency on one exchange and selling it on a different exchange where the price is significantly higher than it is on the first exchange. This results in a profit.

In this article, we will explain everything you need to know about how to arbitrage cryptocurrency, including how to arbitrage Bitcoin. Also, we will show you how you can take advantage of cryptocurrency arbitrage opportunities while at the same time understanding and mitigating the risks involved with it.


Cryptocurrency Arbitrage: The Basics

Arbitrage opportunities have long existed for traditional assets such as stocks, bonds, and foreign currencies. However, finding them typically requires sophisticated systems, which are out of the reach of most investors. But crypto exchange arbitrage is the exception to the rule.

What drives this accessibility is the very nature of cryptocurrency exchanges. There are many of these exchanges all over the world. Moreover, they vary greatly in trading volume, available liquidity, and prices. Often, the large cryptocurrency exchanges, which generally have higher liquidity than smaller exchanges, experience a rapid surge in trading that dramatically affects prices. But it also often takes some time before these price changes affect the prices at the smaller exchanges. This is when the opportunity for arbitrage arises for those who can spot the differences in prices.

In general, cryptocurrency prices are lower at larger exchanges. This is because of the higher liquidity and higher trading volumes. So, one common means of crypto arbitrage is buying currency from one of the larger exchanges and selling it at the smaller ones. But during the surging of prices, opportunities for crypto arbitrage also exist in the opposite direction as well. This is because the prices at the smaller exchanges usually do not adjust as fast as they do at the larger ones. Furthermore, you can sometimes buy cheap currency there and then sell it on one of the larger exchanges for a significant profit.


Cryptocurrency Arbitrage: Approaches

The simplest approach to cryptocurrency arbitrage is to manually monitor the prices of cryptocurrencies across a wide range of exchanges, and then make a pair of trades (both buying and selling) when you spot a discrepancy in prices. But this process is time-consuming, requires a lot of work, and easy to miss opportunities. Even worse, it is slow to execute. It could hamper your ability to maximize your profits.

A better approach is using something called a bot, which many offer online, often for free or for a small fee. A bot is a computer script that is constantly running while checking for discrepancies in prices among the world’s leading cryptocurrency exchanges. Many of these bots allow you to fine-tune what to look for. Furthermore, they can initiate trades for you when you are away from your computer or even when you are asleep.

You can also use a hybrid approach. This entails using cryptocurrency trading apps that can help you monitor exchanges while still trading manually, which allows you to have more control than a bot.

Depending on your circumstances, you may also be able to engage in crypto arbitrage through a hedge fund. Kit Trading, for example, is a Singapore-based hedge fund that has raised $10 million specifically for crypto arbitrage. The advantage of this is that a hedge fund is likely better capable of both finding discrepancies and taking advantage of them. Besides, it is also better able to withstand the risks involved in this type of trading.


Cryptocurrency Arbitrage: Strategies

There are several strategies you can employ to engage in cryptocurrency arbitrage. This includes:


Simple Arbitrage

As the name implies, this is the easiest form of crypto arbitrage and one of the most common. You buy a particular cryptocurrency, such as Bitcoin, on one exchange at a low price and you sell the same cryptocurrency for a higher price on a different exchange.


 Triangular Arbitrage

Triangular arbitrage is a little more complicated than simple arbitrage. Instead of buying and selling a single cryptocurrency on different exchanges, you buy three separate digital currencies, taking advantage of discrepancies that exist between certain trading pairs. For example, you may find it advantageous to trade Litecoin into Bitcoin on a particular exchange if you first trade your Bitcoin into Ethereum on one exchange and your Ethereum into Litecoin on yet another exchange.


Convergence Arbitrage

In convergence arbitrage, instead of buying and selling a cryptocurrency, you buy currency at one exchange where it is selling lower than the market value. You need to sell it at the second exchange where it is selling higher than the market value. You profit when the prices meet.

Cryptocurrency Arbitrage: Strategies
Photo by Marcin Rabiej on Coinmonks


Cryptocurrency Arbitrage: Benefits

There are many good reasons for engaging in cryptocurrency arbitrage. They include:


Quick Profits

Profiting from standard crypto trading techniques can take a long time. You have to wait for an expected outcome to occur, which may or may not happen. With crypto arbitrage, your profits are instantaneous once you discover a price discrepancy and initiate a pair (or trio) of trades.


No Shortage Of Opportunities

Unlike in most traditional financial markets, there are hundreds of exchanges around the world that deal in cryptocurrencies. Besides, this number is constantly growing. Additionally, this provides a near-limitless number of opportunities for crypto arbitrage.


It Is A Nascent Growth Opportunity

Cryptocurrency trading is both new and popular. It provides lots of opportunities for those who are willing to take risks. Most exchanges are unregulated and uncoordinated with each other. Big financial institutions are largely uninvolved in the markets. This means that there are more opportunities for arbitrage than in traditional markets since fewer people are looking for them. Also, the newness and popularity of cryptocurrency trading have led to great volatility. Unlike in most forms of trading, volatility is a good thing for those engaged in crypto arbitrage. The more volatile markets are the better since this creates opportunities.

Cryptocurrency Arbitrage: Benefits
Photo by Rohitha Elsa Philip on Data Driven Investor


Cryptocurrency Arbitrage: Risks

Engaging in cryptocurrency arbitrage does come with some risks. There are also hindrances as well that could keep you from doing it successfully. These include the following:


Exchange Risk And Fees

Crypto arbitrage requires that you store your currency on various exchanges. This is not without risk, as hundreds of millions of dollars have been infamously lost due to the theft of various varieties on exchanges. What’s more? Last year users at a major Canadian cryptocurrency exchange lost access to all their digital money. It happened when the owner of the exchange suddenly died and took everyone’s private keys to the grave with him.

You will also have to pay fees when trading cryptocurrency. These fees, which cut into your profits, vary by exchange, and they can be applied to a variety of transactions, such as:

  • Trades
  • Deposits
  • Withdrawals


Capital Requirements

Crypto arbitrage often involves taking advantage of slight discrepancies in prices. This means that to fully take advantage of them in any meaningful way, requires the trading of a significant amount of cryptocurrency, and this may be beyond the means of some investors.


Speed Requirements

Successfully engaging in cryptocurrency arbitrage requires all kinds of swiftness. As mentioned above, cryptocurrency markets are highly volatile, which means that the price of a currency can dramatically change in a very short time. So, even if you find a terrific opportunity for crypto arbitrage, you may not have sufficient time to execute the required trades. Exasperating all this is the fact that transaction times can be slow. It is more than possible to imagine a scenario in which you buy a large amount of cryptocurrency but are unable to sell it because the transaction took too long to complete, leaving you holding cryptocurrency you cannot unload at a good price.


Regulatory Requirements

While cryptocurrency exchanges have been notoriously unregulated in the past, this is steadily changing. Many exchanges are imposing restrictions that may make it difficult, if not impossible, for you to trade from your particular locality. This could severely limit your opportunities.

While the risks in crypto arbitrage are significant, you can offset them somewhat by following these tips:

  • Only trade on cryptocurrency exchanges that have a good reputation. This can limit your opportunities for finding price discrepancies, but losing opportunities is far better than losing all your money.
  • Limit your exposure to losses by never trading more than you can afford to lose. Also, learn about and implement hedging strategies, and diversify your holdings as much as possible by holding accounts on multiple exchanges with multiple currencies.
  • Avoid trading in Bitcoin. Because Bitcoin can have notoriously slow transaction times, it is often better to use other cryptocurrencies when engaging in cryptocurrency arbitrage, such as Ethereum or Ripple.

Leave a Reply

Your email address will not be published. Required fields are marked *