There are many ways to make money from trading cryptocurrency, one of which is arbitrage. However, arbitrage is not peculiar to cryptocurrency. Arbitrageurs have been taking advantage of arbitrage even in the traditional financial market. By buying a security from one exchange where the price is low and instantly selling it in another exchange for a higher price, a trader can exploit the price difference. The discrepancies in the price of cryptocurrency across many exchanges give room for arbitrage opportunities.
What is Arbitrage?
Arbitrage is the act of simultaneously buying and selling assets from different markets and exchanges to make a profit from the price discrepancy. The price discrepancy or imbalance is known as the spread. To carry out arbitrage, you have to purchase an asset from one exchange at a lower price and immediately sell the asset at another exchange for a higher price.
Similar to sports arbing and fiat arbitraging, crypto arbitrage is the process of buying a crypto asset in an exchange where the price is low and selling it where the price is higher. However, this is only one of the different ways of crypto arbitrage. Traditional fiat currency traders rarely enjoy the benefit of arbitrage. On the other hand, there are several ways an arbitrageur can benefit from crypto arbitrage.
Big crypto exchanges follow the force of demand and supply to determine the price of an asset. If the demand for a particular asset, say XRP, is low in an exchange, its price will drop in that exchange, but if the demand is high its price will rise. Most of the smaller exchanges follow the price set in big exchanges. If you would like to learn how to buy cryptocurrency, read here for more.
Types of Crypto Arbitrage
It is the most simplistic form of arbitraging. In spatial arbitrage, you buy a cryptocurrency in an exchange and immediately sell it in another exchange, gaining from the price differences in the two exchanges. To take advantage of spatial arbitrage, you have to buy where the price is low and sell where there is a significant price rise. For instance, you can buy 1 Bitcoin at the rate of USD40,200 from Gemini and sell the same volume of BTC at USD40,310 on Binance.
The problems with this kind of arbitrage include transaction costs on the two exchanges and transfer time. You have to be very fast with your transaction, otherwise, the price might have risen where you intend to sell.
This involves trading three pairs of cryptocurrencies in one exchange simultaneously. According to statista, as of October 2021, there are over 6000 cryptocurrencies in existence and you can pair any of them together to carry out triangular arbitrage, especially the prominent ones. For instance, you can trade BTC for ETH, ETH for DOT, and DOT back to BTC. The problem with triangular arbitrage is that it can be difficult for people who are new to cryptocurrency trading to be able to compare the price of different assets or know which assets to pair.
If you are confused, then multiply the amount you are trading by the exchange rate of the first pair of cryptocurrencies, then divide it by the exchange rate of the third pair of cryptocurrencies. If the answer is more than the amount you want to trade, then you can make a profit, that is, after you deduct trading fees.
Rather than jumping from one exchange to the other and risking technical issue and slippage, using a bot to automatically carry out the trade is more assured. The high levels of volatility in crypto exchange can lead to a change in the intended price and rather than profiting from arbitrage, you can make a loss. Rather than constantly checking for opportunities, a bot can perform the task automatically and in less time. The moment there is a slight change in price which a crypto trader can benefit from, the bot will capitalize on it.
Crypto arbitrage bots use algorithms that analyse data and trends, especially coin prices across many exchanges then carry out trades based on the observed differences. A bot is quite an investment and experienced crypto traders take advantage of this rather than sitting with their computers constantly checking for price differences.
To benefit from crypto arbitrage:
Ensure the fee charged on your transaction is not as high as the profit you are making. For instance, if the price discrepancy is USD20, do not automatically assume that that is your profit. Factor in the withdrawal and sometimes deposit fees that will be deducted by the exchange. You can as well divide your crypto assets across multiple exchanges, this will reduce the impact of the charges during arbitrage.
As an arbitrageur, time is of the essence. While waiting for your transaction to be processed, slippage can occur which might make you lose money. To sell at a higher price on a different exchange, you need to develop a fast and efficient method of arbitrage and stick to it because the cryptocurrency market is very volatile and might not work in your favor.
Use secure hot wallet exchanges. Most centralized cryptocurrency exchanges provide hot wallets for users to keep their assets and they are susceptible to attacks by hackers. To protect your money from getting lost, carry out proper research on the exchange you want to use. More often than not, if it is too good to be true then it is not true.
In cryptocurrency, it is very common to find different exchanges offering the same digital currency at different prices. Taking advantage of the price imbalance does not come without its risk. However, if you can do your due diligence, you can benefit highly from crypto arbitrage.
This article is for information only and does not constitute investment advice.