What Is Crypto Arbitrage Trading?
Crypto arbitrage trading is a financial strategy that involves buying and selling cryptocurrencies in sync to generate profit. Each trader shares the same goal: exploit any price differences between the exchange platforms on which the crypto is traded.
Arbitrageurs, those who use crypto arbitrage trading, are often experienced investors. They study and observe how to take advantage of the market’s small price differences and turn it into potential profits.
When Bitcoin hit its all-time high in 2017, data shows that $19,600 was the highest price paid for Bitcoin on Kraken, a crypto exchange. However, other exchanges showed different price highs reflective of the trading history of their users, with some recording prices as high as $20,093.
Apart from that, it is important to note that crypto arbitrage trading is highly risky and may only be attempted by veteran traders with adequate capital. The risk of this is that the asset price can change quickly, which can lead to a loss on the investment.
A Real-life Example
For instance, the stock of Microsoft trades at $50 on the New York Stock Exchange (NYSE) and $51 on NASDAQ.
A trader may observe and study these differences to buy stock on NYSE and immediately sell the same shares on NASDAQ, earning a profit of $1 per share. Accordingly, the same principle is applied to cryptocurrencies too.
The trader can continue to exploit this arbitrage until the specialists on the NYSE run out of inventory of Microsoft’s stock, or until the specialists on the NYSE or NASDAQ adjust their prices to wipe out the opportunity.
What Are the Types of Arbitrage?
Trading virtual currencies between two separate exchange platforms are known as spatial arbitrage. This is the simplest method of carrying out a crypto arbitrage. While spatial arbitrage is a straightforward strategy that can profit from price differences, it exposes the traders to costs and transfers time risks.
Triangular arbitrage exploits inefficiencies in price between various cryptocurrency pairings traded on the same exchange. In this approach, an investor starts with one cryptocurrency and then exchanges it for a second one that is discounted in comparison to the first one on the same exchange.
The investor would then exchange the second coin for a third one, which is considerably more expensive than the first. The investor would then complete the circuit a little richer by exchanging the third cryptocurrency for the first coin.
In simpler terms, a triangular arbitrage method requires investors to spot the price differences between three cryptocurrencies on the exchange. For instance, purchase Binance Coin (BNB) with Bitcoin (BTC), sell BNB to Ethereum (ETH) and convert the ETH back to BTC.
This is the introductory form of arbitrage trading where a dealer tries to induce profit by buying crypto on one exchange and dealing it on another exchange.
How Does Crypto Arbitrage Trading Work?
The two key points are:
- There must be an imbalance in an asset price across exchanges. Crypto arbitrage is usually done with the same assets but at different market prices.
- The two trades must be executed simultaneously on different exchanges. The token is bought on the exchange that has a lower price and at the same time sold on the exchange with a higher price.
Even if Bitcoin spreads aren’t generally as wide as in the aforementioned example, other, lesser-known varieties of cryptocurrency occasionally provide even wider gaps. With thousands of cryptocurrencies trading on hundreds of exchanges, arbitrage possibilities might arise since cryptocurrency prices can vary from one exchange to another.
Investors can download a variety of apps that follow Bitcoin and other cryptocurrency values in search of arbitrage possibilities. Investors can benefit from algorithms that automatically search for arbitrage across many cryptocurrency exchanges in this way. By using an automated process, cryptocurrency arbitrage traders can profit from a variety of price differences.
What To Consider in Arbitrage Trading?
Whether you are looking to arbitrage trade for the first time, or if you are an experienced trader, there are a few things to take into consideration.
- Fees – Fees should be taken into account when trading because they can cancel out any possible gains. You may wish to avoid arbitrage disparities below 0.30% (e.g., Kraken fees range from 0.1% to 0.26%).
- Avoiding Slippage – Price slippage occurs once you get a different price than expected on an entry or exit from a trade. Thus, extensive research and excellent timing of the market become a crucial component of arbitrage trading.
- Liquidity – The markets you trade on must have enough liquidity for you to purchase and sell without significantly changing prices. You might not be able to complete your trades at the prices you desire if there is insufficient liquidity.
Crypto arbitrage appears to still be a workable plan of attack for those hoping to profit from the cryptocurrency market in 2022. Crypto arbitrage trading seems to be still a viable strategy to make money, despite some difficulties, including greater regulation and volatility. Therefore, if you want to earn extra money in the upcoming year, keep an eye on prices and see if you can seize any possibilities that present themselves.
With modern technology, most of these tasks are automated. There are several platforms available today which automate the process of finding and trading price differences across multiple exchanges.