Cryptocurrency Arbitrage 101 [Beginner’s Guide]

Cryptocurrency arbitrage is all about leveraging prices to make a profit. People have been trading crypto for years, but each exchange sets unique values to each currency for various reasons. Cryptocurrency arbitrage aims to help investors profit off of those price differences.

However, it’s risky—the crypto market is known for its volatility. Cryptocurrency arbitrage is a technique that gives traders a chance to profit from the market’s inefficiencies. These trades must get made instantly and simultaneously to earn a profit since the market fluctuates constantly.

Related: Cryptocurrency for Beginners

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Cryptocurrency Arbitrage Defined

The concept of arbitrage has been around ever since the stock and bond markets emerged. Arbitrage refers to buying and selling the same thing on a different market in order to make a profit off of the difference in listing prices.

Opportunities to take advantage of arbitrage might happen when there’s a sudden surge in trading volume within an exchange. Smaller marketplaces tend to follow the prices of larger ones, but the changes don’t take place instantly. That’s where arbitrage happens.

Bigger exchanges often offer better prices, causing smaller exchanges to try and compete by offering something similar. But, because crypto prices depend on supply and demand, the smaller markets might be more stable.

How Does It Work?

Arbitrage can happen due to various market factors, but the major one is the difference in trading volume between two exchanges. In larger markets, the trading volume might be high, leading to lower prices. However, in smaller exchanges with a minimal trading volume, the price of the same crypto might be significantly higher.

Cryptocurrency arbitrage also happens when a coin is listed on the most popular exchanges. Geography also plays a role—buying and selling currency may be easier or harder during certain times of the day. To be successful with arbitrage, you have to find the right opportunity, and once you find it, act quickly. For most major coins, it takes 15-20 minutes to confirm a transaction. During that time frame, if the price drops, you run the risk of turning a loss.

Simultaneous arbitrage isn’t common in crypto due to the market’s infamous volatility. Sometimes, you might have to wait a few days to profit from the perfect arbitrage, but the timing can be tricky. When executing the arbitrage, it’s essential to double-check everything. Look at your analysis of the sell and buy listings and closely examine the trading volume again.

There are also programs that will do the work of arbitrage for you, but security is often a risk with those programs. To perform arbitrage, you’ll need to open up accounts on a variety of exchanges, making you vulnerable if any platform has a security breach. Also, there are non-reputable exchanges that may simply steal your coins.

Three Types of Cryptocurrency Arbitrage

Here are the three most used ways to find and profit from crypto arbitrage:

  1. Spatial Arbitrage

Spatial arbitrage is the most common one. It’s when a trader buys crypto on one exchange and transfers it to another, selling it for a higher price.

The downsides to this are issues like transfer times, spreads, and costs. By the time you transfer the assets to another exchange, there’s a good chance that the prices have already changed.

The upside is that it’s the easiest method of arbitrage.

  1. Spatial Arbitrage Without Transferring

This arbitrage method eliminates the costs and transfer times, and it’s also the most preferred way to perform arbitrage by most crypto traders.

Let’s look at an example.

Say you look into the spreads of the asset ETH-USD and decide to buy it on one exchange (A) and sell it on another (B). You would move the USD to exchange A and the ETH to exchange B. 

You would then wait for the price difference to hit your determined percentage on exchange B. When it does, you’ll submit a buy ETH order using the USD on exchange A and simultaneously commit to selling the ETH order for USD on exchange B.

This means that you simultaneously bought and sold 1 ETH. You didn’t gain or lose any crypto, and you profit from the price difference minus trading fees.

  1. Triangular Arbitrage

Triangular arbitrage focuses on converting crypto into other currencies. For example, you can trade BTC for ETH, then trade the ETH to LTC, and the LTC back to BTC. If the price differences were substantial, you could make a decent profit.

Because each exchange offers a variety of crypto options, there’s a potential for profit using triangular arbitrage either on a single exchange or across multiple ones. It’s not as common as spatial arbitrage, especially for less experienced traders, because it comes with higher risks. However, the potential for gains is higher.

Is Cryptocurrency Arbitrage Profitable?

Yes, but there’s no guarantee. To perform arbitrage, you’ll need the right knowledge and tools. Without them, it’s almost impossible to generate a profit. In some situations, there might be a large spread that leads to a huge profit, but it’s also easy to see significant losses.

If you’re a day crypto trader and market movement is low, you can almost always earn at least some profit from arbitrage. Speed and persistence are key. Spatial arbitrage is the most common form, which is where traders purchase crypto from one exchange and sell it to another. However, this can be ineffective at times.

 By the time you buy crypto and get it validated by miners, the market may have moved for or against you. Then, when you sell it on another exchange, the price can vary, meaning you might not see the profit you wanted. Another factor to look at is extra fees, which can significantly decrease your arbitrage profit.

Arbitrage also causes the price of crypto to rise at the exchange you purchase it from and causes an opposite movement on the exchange where you sell it. Doing so causes the prices to move closer to each other, making it difficult for multiple people to profit via arbitrage.

In the beginning of crypto trading, trades were made manually. However, with technological advancements, computerized trading took over. Price fluctuations get monitored at all hours, and each trade gets executed almost instantly, eliminating price errors and lowering the odds of seeing arbitrage opportunities.

To find these opportunities, you’ll need access to multiple listings at the same time, which can be made easier by using arbitrage tools and software. Because crypto exchanges operate 24/7, there’s no way to stop arbitrage completely. 

The Legality of Cryptocurrency Arbitrage

Is it legal? 100% yes. Each crypto exchange offers a unique rate for specific coins. While the prices are very similar between each one, there are often small deviations.

Crypto is decentralized, volatile, and still in development. Due to this, opportunities for arbitrage are much more frequent than in other markets.

Crypto arbitrage opportunities arise due to market inefficiencies, not due to the actions of traders. However, as more people engage in crypto arbitrage, there are fewer opportunities to go around—frequent trading between exchanges nullifies price differences.

Arbitrage helps the market stabilize, and it increases the trade volumes on different exchanges.

Related: Cryptocurrency Investing Mistakes

Pros & Cons of Cryptocurrency Arbitrage

Let’s look at cryptocurrency arbitrage’s pros and cons:

Crypto Arbitrage Pros

  • Fast profit—You can perform arbitrage as soon as the transactions are complete, which is typically around an hour. It offers the potential for much quicker profits than traditional “buy and hold” cryptocurrency trading.
  • Range of opportunities—There’s a wide variety of exchanges in the crypto market. Because of the number of exchanges, there are a lot of crypto arbitrage opportunities out there.
  • Crypto volatility—Although Bitcoin (the first cryptocurrency) was launched back in 2009, it’s still one of the most volatile cryptos on the market due to fluctuations in supply and demand. Because of crypto’s volatility, there can be massive price differences between exchanges, presenting arbitrage opportunities.
  • The developing market—Even though crypto trading is becoming more popular, it’s not widely accepted by the public. You could say the market is still in development. There’s a widespread lack of information and a bit of irregularity of information sharing between exchanges. There are also fewer traders in the crypto market, meaning less competition and more potential price differentials.

Crypto Arbitrage Cons

  • KYC restrictions—When trading on any exchange, you must follow the KYC regulations. Sometimes, you’ll need to own a bank account in the country the exchange is based in, or you might have to link your account and verify your identity. It can take up to a day to get your account verified via the KYC before you can start trading.
  • Coin storage—For arbitrage, you’ll need access to various exchanges, meaning you’ll need to store your coins across all of them. Since they’re stored online, they are susceptible to security breaches. Lesser-known exchanges have stolen coins from their customers in the past.
  • Fees—You can’t make deposits, withdrawals, or trades for free on crypto exchanges. They charge a percentage of your coins as a fee, so you’ll have to take those into account when calculating your arbitrage profits.
  • Trade volume—Because of the fees mentioned above, profits might be quite small. To make large profits from crypto arbitrage, you need to trade in high volumes, which can be expensive and risky.
  • Timing—Each transaction can take ten minutes or more to go through and get verified. Within that period, the market can move against you, turning your arbitrage profit into a loss. There are plenty of cases where traders lost money as the market shifted while waiting for verification.
  • Transaction speed—With rising trade volumes on global crypto exchanges, transactions take longer to complete, which can be a major issue if you need to transfer funds quickly. 
  • Withdrawal limits—When making large trades, you’ll need to keep in mind that some exchanges have daily withdrawal limits.
  • Competition—You’re not the only trader looking for arbitrage. More competition means reduced opportunities and more changes in trading volumes on various exchanges.

What To Know Before Getting Started

Thinking about investing in arbitrage? Read this first.

  • New listings—Always look for new crypto listings. When a coin gets listed on the exchange for the first time, there’s likely little to no demand for it, which is great for arbitrage traders.
  • Avoid BTC—Bitcoin (BTC) transactions can take a long time. Because arbitrage requires quick trading, slow transaction times hurt your chances at a profit. You might want to consider altcoins like ETH, which offer faster transaction times.
  • Plan, plan, plan—Before you begin looking for arbitrage, there are a few questions and factors to consider. It’s essential to plan how much goes into each trade. What percentage of profit will come from it? What fees will reduce that profit? Having a clear plan will help you seize the best arbitrage opportunities and answer those questions.
  • Monitor the market—Arbitrage opportunities can show up any time. You need to watch the exchanges closely to find them. During market volatility, price differences are more significant, so you’ll need to monitor developments and recent news that might lead to changes.
  • Diversify—Limiting your trading to only a few exchanges will severely limit your arbitrage opportunities, or you might only see minuscule profits. To earn more, it’s crucial to trade on a variety of exchanges, and this also reduces the risks that come from not diversifying.
  • Limit your losses—Because of crypto’s volatility, it’s important to trade quickly or even not at all. Sometimes, the risks outweigh the rewards, and it’s better not to lose your money than it is to gamble on a possible arbitrage opportunity.
  • Hedging—To help protect from market changes, it’s essential to use hedging strategies. They can help you avoid potential losses but can also reduce your potential profits. Hedging is similar to an insurance policy protecting you from imminent damages. 

There are a variety of arbitrage opportunities and techniques that traders can benefit from whenever there is volatility and inefficiency in a market. However, as more traders look for arbitrage opportunities, they begin to disappear quickly, helping stabilize the market and the price of crypto across exchanges.

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