A huge amount of cryptocurrency is traded on various cryptocurrency exchanges daily. Unknown to some, you can profit off of price differences in these crypto exchanges. This process is referred to as crypto arbitrage. Learn more about earning from crypto arbitrage, its types, and benefits from this article.
What is crypto arbitrage?
Crypto arbitrage refers to a trading strategy that involves buying and selling cryptocurrencies on different exchanges at different prices to earn profit. This trading strategy is not new to the investment world. In fact, it has been long used in the stock market where an asset would be bought at a lower price in one stock exchange and later sold for a higher price in another stock exchange. With the advent of crypto, many traders have now adopted this strategy to earn profit. Crypto arbitrage is governed by the general rule of trading, “buy low, sell high”.
To understand the concept of cryptocurrency arbitrage better, we will use a story. Zoe discovered cryptocurrency arbitrage through an article from Vestinda and decided to try it for herself. She went over to crypto exchange A and assessed an asset that sold one unit for $95. She then went over to crypto exchange B to check the price of the same asset. Alas, the price was $100! This meant that she could make a $5 profit from just one unit. Zoe went over to crypto exchange A and bought $950 worth of the asset. She then proceeded to crypto exchange B and sold the asset for $1000. Now Zoe had made a total profit of $50 just by the differing prices in the crypto exchanges.
One might ponder the reason for the difference in prices of the same assets in different crypto exchanges. A reason behind the deviating prices can be found in the operations of the exchanges. For instance, crypto exchanges with higher trading volume and more liquidity are found to have lower prices. Another thing to take into consideration is an exchange’s trading fees. Different exchanges have varying trading fees, with some higher and others lower. As you might guess, crypto exchanges with lower trading fees will tend to sell their assets at a lower price and vice versa. Recall that the crypto market is governed by the forces of demand and supply. Hence, price levels are largely affected by the trading volume of an asset. An asset can be traded more in one exchange than the other simply because of the popularity of the exchange. In such cases, there would be an obvious difference between the prices of the two crypto exchanges.
Types of crypto arbitrage
Cryptocurrency arbitragers use different arbitraging methods to profit from the cryptocurrency market. The most popular types of arbitrage methods are:
- Triangular Arbitrage: This arbitrage method involves trading the differences between three cryptocurrencies on one exchange. Since the fees are lesser, traders capitalize on the price differences between the cryptocurrencies to earn profits.
For example, a trader can start a trading triangle that starts and ends with Binance Coin (BNB). They could exchange BNB for ETH, ETH for ADA, and ADA for BNB. This means the transaction will pass three trading pairs; BNB/ETH, ETH/ADA, and ADA/BNB. If there are differences in the prices, then the trader will close the trade with more BNB than they started with.
Triangular arbitrage can be profitable, depending on the trader’s strategy in choosing trading pairs. Also, everything happens on one exchange, so there is a reduction in transaction fees.
- Cross-exchange Arbitrage: This arbitrage method is done by buying cryptocurrency on an exchange at a reduced price and then selling on another exchange at a higher price.
This kind of arbitrage might be profitable, but a few problems are associated with it. Sometimes, the spreads last only seconds, but transactions may take a few minutes to complete. However, you may avoid this problem by doing a deeper technical analysis of the cryptocurrency you want to arbitrage.
Another problem faced by cross-exchange arbitragers is transfer fees. Moving crypto from one exchange to another incurs charges through either network, deposit, or withdrawal fees. You may be able to navigate this problem by having currency on the two trading exchanges. For example, a trader might have 500 USDT on Binance and 1 BNB on Kucoin. If BNB is valued at $300 on Binance and $350 on Kucoin, then the trader can buy the BNB with the stablecoin on Binance and then sell off on Kucoin. They would not gain or lose a BNB but make $50 due to the spread between the two exchanges.
- Decentralized Finance (DeFi) Arbitrage: This arbitrage method is done on decentralized exchanges and automated market makers (AMMs) by utilizing smart contracts to find the prices of crypto trading pairs. Suppose one platform offers a 12% yield from a cryptocurrency, and another offers 13.5%. In that case, a trader could carry out a cross-platform exchange from the lower platform to the higher platform to earn the extra 1.5%. Some platforms automatically do this by moving funds across different DeFi pools to get the best yield.
- Statistical Arbitrage: This method of arbitrage is done using computational data models to trade cryptocurrencies. Using bots and statistical models, traders can execute high-frequency arbitrage trades with significant profits. A good trading bot should be good at creating trading strategies using statistical data to predict the price of cryptocurrencies and then trade them expertly.
Crypto arbitrage bots
Crypto arbitrage bots are automated software that uses technical analysis to determine the right buying and selling points. If you perform arbitrage operations on a large scale, it might be hard keeping up with it manually. Also, monitoring the perfect buying and selling points are quite daunting. This is why crypto arbitrage bots are employed. Crypto bots use past data to analyze the market to make price predictions or future market trends. It also makes crypto arbitrage trading more efficient and convenient.
Benefits of crypto arbitrage
Traders have gained massively from crypto arbitrage. Here are some benefits of crypto arbitrage:
- Low risk: Crypto arbitrage is not only a fast means but also a low-risk method of earning. Not much time is given for volatility to take its course, which could cause difficult losses. Trading between exchanges is almost immediate, leading to a clear price knowledge by the trader.
- Market volatility: Volatile markets give room for fluctuating prices across different exchanges. Also, some crypto exchanges might catch up on price volatility faster than others. Meaning that if there is a price increase of an asset, Exchange A’s price might rise before Exchange B’s price. Hence, you could quickly profit off volatility between the two exchanges.
- Crypto exchange options: With crypto arbitrage, the crypto exchange options are endless. There is no monopoly of exchanges where users would have to put up with a few. Should any faults arise, there are other options to choose from.
- Quick rewards: Unlike some other investment options, you earn your profits quickly. This is because trading on either platform is done simultaneously. Hence, you do not have to wait so long to reap your rewards.
Risks of crypto arbitrage
Although crypto arbitrage has brought numerous benefits, it still holds drawbacks. Here are some risks of crypto arbitrage:
- Fees: Withdrawal and deposit fees might be a hindrance in reaping your total profit. A good part of your profit might go into settling such fees. You also have to keep in mind that both exchanges will require their respective fees. Hence, you need to research your chosen exchange fees and compare them to profit.
- Regulation: Crypto as a whole is not new to regulations, and so is crypto arbitrage. Regulation policies could serve as barriers for certain cryptocurrencies. Your geographical location might not support crypto or crypto arbitrage making it difficult to perform its operations.
- Quick trade: Crypto arbitrage involves constant monitoring and swift trading moves. If you are regular on crypto arbitrage, you need to beat market volatility in short periods and be swift at all times.
- Low trading volume: A coin may have a low trading volume on its coin exchange which could hinder you from selling it. You might buy the coin from a certain exchange and hope to sell it for profit. Unfortunately, you may not see any buyers at that point. Otherwise, buyers might only become available when the price decreases. This may cause you to lose profit or hold coins that you did not intend to.
Is crypto arbitrage profitable?
Like everything else in the cryptocurrency world, arbitrage trading comes with risks and problems. Their profitability comes from the fact that there will always be price differences. Still, the profit margin can be pretty low with issues like transfer charges, technological malfunctions, longer transaction times, and shorter spreads. Regardless, it is safer than most trading methods, which is why it is regarded as a low-risk, low-profit venture. Also, leaving an error margin is essential to help curb the unprecedented losses.
Crypto arbitrage is a low-risk yet profitable venture. While the profit margin might be low due to high transfer fees, arbitrage trading is still considered the safest trading method. If you are a beginner trader or you don’t want to risk your capital too much and still want to make profits, then arbitrage trading might be the best option for you.
Founder & CEO of Vestinda.
Compacting years of investment portfolio building into just a few minutes.