Have you ever heard of cryptocurrency arbitrage before and wondered what it’s all about?
Crypto Arbitrage is a technique that many people have used in this growing crypto world to make quite a bit of money and it’s potentially a less risky way of trading than the traditional ways of trading like swing trading or day trading.
What is Arbitrage?
Arbitrage is the simultaneous and spontaneous purchase of securities or foreign exchange from different markets and then sell them on other markets in order to profit from price discrepancies. In other words, it refers to the purchase of stock from a seller with a view to selling it profitably to the buyer.
Crypto Arbitrage Trading
Basically, the idea behind crypto arbitrage is that you buy a crypto asset in one market and then sell it in another market where it has a different price in order to profit off from the difference this is highly considered a risk-free trading technique or at least pretty close to it if there ever is one.
To profit from this type of trading all you need to do is find an asset that has different prices even though it’s the same asset in different markets. This arbitrage technique can be used with stocks, bonds, Forex, and other tradable commodities.
That’s why it’s kind of hard to find it in traditional markets because it’s an old technique and many people are already taking advantage of it or have automated systems in place to do most of the arbitrage trading these days only to keep the prices stable across the markets.
However, this system only applies to the traditional markets and not to cryptocurrencies.
The cryptocurrency market is unique and since this market is quite a different one from all the traditional ones and it has over 200 cryptocurrency exchanges with a large price distribution. I mean just going to look at Coinmarkecap, click on a coin, and then click on markets and you will clearly see all the price differences.
These price differences are mainly due to the imbalances between supply and demand and also due to separate mechanisms for price discovery of a crypto coin by different cryptocurrency exchanges.
Since price discovery is kind of done separately by each exchange it results in high volatility within the prices of an asset in different exchanges.
Larger exchanges with the liquidity constantly drive the price and then small ones follow them but it’s not immediate, sometimes the big ones change the prices suddenly, and then the small ones are slow to catch on to it and that is where the crypto arbitrage opportunities exist.
The biggest profitable example for crypto arbitrage trading would be the Kimchi Premium.
Back in the time of the biggest bull run of the cryptocurrency world, South Korea had a huge premium of 30 percent or something like that on Bitcoin so if it was selling for N amount of dollars in the USA it would be selling for 30 percent more in South Korea and that is called the kimchi premium.
It would have been incredibly profitable if you did crypto arbitrage trading at that time.
There are many different types of crypto arbitrage tradings the simple type Fiat triangular arbitrage crypto triangular convergence catch and carry
As the name suggests, simple arbitrage is quite simple.
You buy a coin on one exchange and sell it on another exchange at the same time or close to the same time. Then you can earn the spread which is the difference between the prices instantly. In some situations, you can transfer the coins between exchanges but that takes some time.
Another cool technique to do this is to have fiat and crypto balances on both exchanges so you can effectively buy and sell on one exchange to another one at the same time. You will need a good amount of investment to succeed in this technique.
Fiat Triangular Arbitrage
Fiat triangular arbitrage refers to when you have three assets involved or have two asset pairs involved with one shared asset between the pairs.
For example Bitcoin-US dollar and Bitcoin-Korean Won KRW. Here bitcoin is a shared asset but there are three total assets that we’re dealing with.
Now suppose you buy one Bitcoin for 9000 on Coinbase, send it to a Korean exchange, and sell it for $10200 worth of Korean Wons and then you can convert your Korean Wons to USD at a bank per se for $1200 profits.
These types of opportunities are often found in the exchanges that serve local as well as regional markets.
This triangular arbitrage is also possible in the crypto world.
Crypto Triangular Arbitrage
You can apply the same technique as the above to the triangular crypto arbitrage trading technique within just one cryptocurrency exchange and take the advantage of mispricing between three pairs of coins.
Take Bitcoin, Ethereum, and Litecoin for example and when considered together, they kind of form a circle triangle per se so if you look on Coinmarketcap the ratios between the coins are denoted in USD value as well.
Now suppose Ethereum (ETH) is converted into Bitcoin (BTC) and Litecoin (LTC) converted into Bitcoin (BTC). Both of these are separate markets so they have different supply and demand that’s why there are price differences and that’s how you can take advantage of crypto arbitrage by going through the pairs to get that price difference in terms of USD value.
You can make more Bitcoins or other altcoins you’re trying to make in that scenario and increase the arbitrage profitability.
There are also BOTS (Automated crypto arbitrage trading programs) available to do this.
Convergence crypto arbitrage is based on the idea that whenever there are market inefficiencies eventually the prices will converge because it’s bound to.
To take advantage of arbitrage opportunities what you can do is buy one crypto coin on an exchange where it’s undervalued and then you short-sell it on an exchange where it’s overvalued. But of course, you need to find an exchange that allows the shorting of that particular coin.
As easy as it sounds shorting is kind of complicated and definitely not for newbies.
So please do a lot of research and testing before you end up trying convergence arbitrage.
Cash and carry arbitrage is mainly utilized because of the Futures markets.
It basically means to go long in the Spot market or the markets that you are familiar with and go short in the Futures market and then carry the asset until the Futures contract expires so that you can settle it with your long position and by doing so you pocket the difference when you deliver the asset.
For example, let’s say the futures price on Huobi for one bitcoin is $9300 but right now on Binance it is $9000. You can buy it on Binance and then short it on Huobi, and then when your futures contract expires you can deliver the one Bitcoin and get paid $9300 for it. That’s how futures markets work.
Usually, this kind of cash-and-carry arbitrage makes sense because there’s no carrying cost associated with digital assets per se and all that you just have to hold it in a wallet either on an exchange or even better on your own hardware wallet, and then deliver it when your futures contract expires.
What are Crypto Arbitrage BOTS?
Bots are the best parts of crypto arbitrage trading because honestly, computers can do this better than us when it comes to algorithmic trading they can execute complex rules quickly and accurately which in turn saves you time and hassle.
You don’t have to sit at your computer all day looking for opportunities and manually executing them and also they aren’t prone to emotional effect. So if a bot is coded properly and has safeguards in place then it will follow that and won’t act like you that might panic sell or panic buy.
Additionally, the more people that use these bots, the less effective they become. That is true for every technique whether box or just regular techniques and they used to work incredibly well during the last bull run when there was a lot of efficiency and volatility.
Why use BOTS?
- Computers can do arbitrage trading better than humans
- Bots can execute complex calculations instantly and efficiently
- Save a lot of time and hassle
- Follows given guidelines in order to reduce risks and maximize profits
Crypto Arbitrage Opportunities
Right now there are not as many opportunities for crypto arbitrage.
However, when a coin gets listed on exchanges it is a big opportunity for example just studied Binance every time a new coin gets listed on Binance it pumps up majorly and that is an opportunity for crypto arbitrage between Binance and other exchanges that already had the coins listed.
Also, different countries play a big role in price differences because access to those exchanges is not the same for every country, for example, European Union had really lucrative price differentials most of the time compared to the USA but you have to have a European Union citizenship or European bank account in order to take advantage of that or else you can’t sign up for an exchange based in EU.
Another thing is liquidity. There can be huge price differences but a smaller exchange does not have a lot of liquidity despite there being a heavy imbalance between supply and demand on them. This means that you can’t really take advantage of this crypto arbitrage opportunity on such exchanges.
Drawbacks and Risks in Crypto Arbitrage
Of course, there are many drawbacks and risks associated with everything you do in the cryptocurrency world or in the financial world.
Crypto Exchange Issues
- Withdrawal Limits – Different crypto exchanges have different transfer limits so even if crypto arbitrage may seem amazing between two exchanges make sure to check whether the trading limits are suitable.
- Account restrictions – Most crypto exchanges have account restrictions. A user can only use features of exchange up to the extent of his identity verifications.
- Hacking – No place is more vulnerable to hacking than a cryptocurrency exchange. A case of stolen funds from an exchange wallet is reported every month or so. So keep your funds in a hardware wallet to be on the safe side.
The fee is a huge deal and it has to be calculated and taken into account. When you calculate your potential profitability, you also need to calculate the following types of fees:
- Maker/taker fee (Taker refers to the buyer and Maker refers to the seller)
- Deposit and withdrawal fees
- Credit/debit card fees
- Other payment method fees
Remember that taxes vary according to the country you’re living in and if you’re doing crypto arbitrage between the exchanges of two countries you will need to know the rules and restrictions of both of them.
For example, if you do crypto arbitrage trading between the USA and Netherlands, you will have to pay a taxation fee on every transaction in the USA while in the Netherlands you don’t have to do so.
This is a high-risk factor because not all trades can be executed due to the constant volatility of the prices. For example, suppose you put in an order a certain price for X amount of Bitcoin, it may not get confirmed because the price might be too volatile and go past that ordered price.
Well, you can’t just execute your trades quickly and successfully at all of your desired prices.
Transfer risks mainly consist of network congestion or wallet maintenance. This congestion of the network and wallet maintenance can sabotage any arbitrage trade on any day. So make sure to choose the right network as well as the wallet.
Useful Tips For Crypto Arbitrage Trading
Some general tips to take into account for when you attempt to do crypto arbitrage.
Execute your trades quickly otherwise you will incur losses more than profits.
Carefully set your trades and check that it executes quickly while at the same time make sure to minimize fees by choosing the right exchanges and processes.
Consider transferring with faster coins. For example, if you need to transfer urgently do it with Ethereum (ETH) or other altcoins instead of Bitcoin (BTC) or transfer with whichever one has less network congestion at the time of the trade.
Before doing actual trading, consider making a detailed plan like what price percentage differences are you going to target, how much capital are you going to spend on a particular trade, what type of crypto arbitrage suits best to you, etc.
Use reputed and trusted exchanges only. Create a demo account and get a good amount of practice on them first before you put a lot of money in and potentially get screwed by those exchanges.
Indulge yourself in the crypto community and pay attention to the crypto world for news and be aware of the potential opportunities. Have your eyes and ears around the community at all times.
Diversify your portfolio. Make sure to diversify in terms of exchanges, coins, and strategies in order to minimize the potential risk from a single commodity. I recommend you invest no more than 5% of the total investment in a single exchange or a coin.
As the saying goes, “Never invest more than you can afford to lose”. So limit your exposure because crypto arbitrage like other types of trading depends entirely on the market. So it’s up to you to decide whether you will trade wisely or go guns blazing.
As you can tell by reading this article crypto arbitrage consists of many factors, I personally wouldn’t try too much hassle to do it.
Though it heavily depends on many factors like volatility, liquidity, availability of bots, type of arbitrage, total capital you have to spend, etc.
However, with more people doing this crypto arbitrage, profits and opportunities will also diminish.
Nowadays, Crypto hedge funds are also entering into it and they can do this way better than any of us because they just have access to more resources than us.
Finally, crypto arbitrage may not be worth it unless you code your own BOT (You can also hire a programmer for coding) and have utilized a unique approach that the rest of the market hasn’t caught on to yet.
That’s it. Thanks for reading.
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