Cryptocurrency arbitrage is the act of buying a digital asset on one exchange and quickly selling it at a higher price on another. There are hundreds of exchanges where cryptocurrencies are traded, and frequently, the price of a coin or token might vary from one exchange to another. Any time a stock, commodity, or currency can be bought at a certain price in one market and concurrently sold at a greater price in another, arbitrage can be employed. The trader has a chance to earn without taking any risks due to the circumstances. It is now very difficult to profit from price faults in the market due to technological improvements. A lot of traders use automated trading systems configured to track changes in comparable financial instruments. Any ineffective price arrangements are often addressed right away, sometimes within a few seconds, eliminating the opportunity. In this article, we’ll investigate how arbitrage trading works, its types, and how it can be profitable for investors. So, let’s begin.

Why Do Cryptocurrency Prices Vary Amongst Exchanges?

Because cryptocurrency markets are unregulated and decentralised, they are not correlated with governments or fiat currencies like the dollar, except stablecoins. One of the primary reasons for the wide fluctuations in cryptocurrency values is the lack of a fixed price for any particular coin or token. Concerning this, various cryptocurrency exchanges have larger trade volumes than others. Thus, the price may vary significantly depending on the supply and demand of a particular exchange. Lastly, trading fees for cryptocurrencies might differ and raise the price of your transactions.

How Does Trading Cryptocurrency Arbitrage Work?

Investing in cryptocurrency arbitrage is profiting from variations in price across several exchanges. Traders—or, more frequently, computer trading bots—keep an eye on cryptocurrency values across many exchanges and geographical areas, looking for instances when the same coin is valued differently.

When traders spot a price disparity like this, they act quickly to seize the opportunity.

Because of the way exchanges set the price of cryptocurrency pairings, arbitrage trading is feasible. On the majority of exchanges, prices are often found through an order book that contains buy and sell orders for certain cryptocurrency assets. Buyers and sellers may bid at various prices depending on the exchange, leading to a mismatch in the prevailing pricing on multiple exchanges.

When a notable price disparity for a particular cryptocurrency is found, an arbitrage opportunity presents itself. After that, you may figure up the possible profit by deducting trading commissions and other related expenses. The last phase involves purchasing cryptocurrency at a lower price on one exchange and selling it at a higher price on another. Since trading bots can identify arbitrage opportunities and execute transactions more quickly than human traders, they often handle this trading strategy.

Types of Arbitrage Trading

Using different cryptocurrency types, investors may participate in crypto arbitrage in 3 ways.

1. Spatial Arbitrage

Trading digital currencies across two separate exchange platforms is known as spatial arbitrage. One simple method of performing crypto arbitrage is spatial arbitrage.

Spatial arbitrage subjects traders to costs and transfer times even though it’s a simple method that might profit from price discrepancies.

Some traders attempt to steer clear of the timing and cost concerns associated with spatial arbitrage. In a hypothetical scenario, they may, for instance, go long on one exchange and short on another, then watch for a convergence of the prices on the two markets. They can avoid moving tokens and currencies across platforms as a result. Trading costs, nevertheless, could still be necessary.

2. Triangular Arbitrage

Using price inefficiencies between many cryptocurrency pairings on the same exchange, triangle arbitrage is possible. This approach involves an investor starting with one cryptocurrency and exchanging it on the same exchange for another, less valuable than the original. The investor would then swap the second coin for a third, which is somewhat more costly than the first, after that. Ultimately, the investor would complete the circuit and maybe become somewhat wealthier by exchanging that third cryptocurrency for the first one.

3. Decentralised Arbitrage

There are frequent variations in pricing across several decentralised exchanges (DEXs). We refer to trading with an emphasis on AMMs as decentralised arbitrage.

Decentralised arbitrage traders look for differences in price across different DEXs. This has the benefit of requiring less costs than utilising a centralised exchange and letting the trader have complete control over their private keys during the transaction. This is a result of custodial crypto wallets not being supported by decentralised exchanges.

How to Benefit From Crypto Arbitrage Using Algorithms

At first glance, cryptocurrency arbitrage seems to be as simple as spotting price disparities between two exchanges and then buying and selling.

During a notable period in 2017, the price of Bitcoin on Kraken was $17,212, but it was just $16,979 on Bitstamp – offering a chance for arbitrage. In that case, purchasing Bitcoins on Bitstamp and promptly selling them on Kraken might yield an investor $233 per Bitcoin.

Even if spreads aren’t typically as large as in the example above, there are situations in which other, less well-known cryptocurrencies might have even larger differences.

With several thousand cryptocurrencies trading on multiple exchanges for cryptocurrency investors, arbitrage opportunities might arise at any time due to the volatility of cryptocurrency pricing. Investors may download several software to track the prices of Bitcoin, Bitcoin Millionaire and other cryptocurrencies for arbitrage opportunities. This kind of arbitrage is when investors may profit from algorithms that automatically explore many cryptocurrency exchanges. With the help of this automated method, traders using crypto-arbitrage may be able to profit from several price differences.

How To Find a Crypto Arbitrage?

There are several methods to identify arbitrage possibilities, and not all digital assets related to cryptocurrencies are made equal in terms of arbitrage.

Method 1: New Software

It might be difficult to identify such possibilities with so many different cryptocurrencies available on so many exchanges. Because of this, many traders use software that tracks the hundreds of crypto exchanges in real-time. An increasing number of companies concentrate on creating solutions to automate arbitrage using cryptocurrencies. Some businesses provide investors with a tool that lets them select an automated arbitrage plan and carry it out on many exchanges.

Method 2: Less Well-Known Cryptocurrencies

Among less common and less traded varieties of cryptocurrency, investors might find wider price spreads for the same digital assets. Still, some cryptocurrencies are more vulnerable to sudden changes in value since they are less well-known. This volatility increases the risk of employing an arbitrage strategy, regardless of whether it is beneficial or detrimental.

What Risks Does Cryptocurrency Arbitrage Present?

Cryptocurrency arbitrage has various possible hazards, just like any other type of arbitrage.

Financial Losses

Investors who want to benefit from cryptocurrency arbitrage must act fast to take advantage of price variations in cryptocurrencies across different exchanges while they are still advantageous.

A trader must exercise caution while dealing in the thinly traded cryptocurrencies, which have the biggest spreads, so as not to manipulate the price of a digital asset by raising or lowering its purchasing or selling price.

Volume

All cryptocurrency exchanges operate similarly, setting their prices according to the most recent deal made on the platform. But it’s important to keep in mind that not all trades are created equal. While some of them trade at very high quantities, others don’t trade as frequently. The liquidity and pricing that are accessible on a particular exchange are influenced by the trading volume on each.

A low volume might mean that the exchange is not able to execute a trade big enough to offer an investor the return on investment they want. Low volume might also indicate that the deal can be completed, but it will take too long to take advantage of the best price.

Costs of Transactions

In addition, traders need to keep an eye on the transaction fees linked to purchasing cryptocurrencies across various platforms. These costs continue to vary from exchange to exchange as the cryptocurrency marketplaces develop.

Scams and Cyber Attacks

The fact that cryptocurrencies are mostly unregulated is an important point to understand before investing. Trading cryptocurrency therefore has a higher risk of fraud, hacking, and complete currency collapse. This is why investors are talking a lot about safely preserving their cryptocurrency holdings.

The Takeaway

When investigating crypto arbitrage, investors should conduct their due diligence as with any other investing strategy. This includes looking into several, lesser-known cryptocurrencies and the software that is available to follow cryptocurrency exchanges in real-time.