What is Cryptocurrency Arbitrage Trading?

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What is Cryptocurrency Arbitrage Trading?

This article will explain what is cryptocurrency arbitrage and how to use it in trading. We will present some examples for better understanding and practice. Let’s get started!

Cryptocurrency Arbitrage

Back in the day, the only cryptocurrency and exchange/wallet known to the public was Bitcoin and Coinbase, respectively. The features and popularity of Bitcoin led to the introduction of many other coins and crypto exchanges.

Unlike traditional centralized exchanges (ex: NYSE), crypto exchanges have their own price of tradable cryptos. In simple words, for a given cryptocurrency, two crypto exchanges typically do not have the same price. But why? In any exchange, the price of a cryptocurrency is determined by the last traded price on that exchange. Since the buyers and sellers are different in each exchange, it is obvious that the price will not correlate completely between all the exchanges.

So, having understood that there are always price differences among exchanges, have you ever wondered that these price changes could be taken advantage of? And how you can potentially make money from Bitcoin and other cryptos? Hence, the concept of cryptocurrency arbitrage comes in.

Getting Started with Crypto Arbitrage

Cryptocurrency arbitrage is about smartly exploiting the prices of cryptocurrency between exchanges. Crypto arbitraging is simple – a cryptocurrency is bought from one exchange and sold at another exchange immediately. The trader buys crypto from an exchange where the price is relatively lower than the other exchange to make a profit off it. Thus, the profit generated is equivalent to the difference between the two prices.

5/5

This ad promotes cryptocurrency within the EU (by eToro Europe Ltd. and eToro UK Ltd.) & USA (by eToro USA LLC); which is highly volatile, unregulated in some EU countries and the UK., no EU consumer protection. Investments are subject to market risk, including the loss of principal.

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As with any asset, the value of Digital Currencies can go up or down and there can be a substantial risk that you lose money buying, selling, holding, or investing in digital currencies.

Cryptocurrency arbitrage has gained immense popularity lately. Cryptocurrency trading involves predicting prices, which requires intense analytical skills. Oftentimes traders choose to automate their trading to maximize profits.

However, with arbitrage, all a trader needs to do is trigger the buy and sell buttons instantaneously. If the buying price is lower than the selling price, a profit is turned in. 

Having said that, there is no guarantee that you will always end up buying for a lower price and shorting at a higher price. With the crypto markets getting more liquid and volatile, you may not be able to catch the price you wished for. Despite it being simple to leverage out the prices, you must be aware of the downsides and pitfalls associated with it.

Defining Crypto Arbitrage

Crypto Arbitrage can be defined as the simultaneous buying and selling of a cryptocurrency to profit from the disbalance in price across different markets or exchanges. The principle to profit from an arbitrage trade is simple: buy low and sell high. Following is an example to understand the definition of arbitrage.

Let us take two exchanges – Binance and Kraken.

BTC/USD Price:

Binance – $31,460

Kraken – $31,670

It is seen that the price of Bitcoin against the US Dollar is different in the same instance of time. And here is where arbitrage can be brought into action. To benefit from arbitrage, BTC must be bought from Binance and sold at Kraken. Since you will be buying for a lower price and selling it for a higher price, the difference between the two prices will be the profit earned. So, if 1 BTC/USD was bought and sold simultaneously, the profit would be $210 ($31,670 – $31,460). Note that, this is the raw profit without taking fees and charges into account.

Selecting Exchanges for Crypto Arbitrage Trading

Presently, there are numerous crypto exchanges in the market. As the options increase, choosing the right exchanges becomes challenging. There are some factors that must be considered and compared between exchanges to decide on the best ones.

Following are a few critical factors that must be taken into account while selecting the right exchanges to arbitrage:

Fees

There are various types of fees, including trading fee, commission, deposit and withdrawal fee, etc. These all together could eat up your profit made from arbitrage. Thus, you should always compare the fees across exchanges and go for the lower ones. The fee difference might not be significant, but its effects will be reflected in the long run.

Geography

Cryptocurrencies are not widely accepted yet, there are restrictions put up in various countries. Some exchanges or their features will be disabled in certain countries. So, traders must research the exchanges and the availability in their countries.

Transaction and Withdrawal Times

In cryptocurrency arbitrage, the transaction time and withdrawal time is a major point to consider. It is necessary that a trader is aware of the average time taken. The lower the transaction and withdrawal time, the better are the arbitraging opportunities.

Verification

Not all exchanges allow a trader to buy and sell right after the account creation. Some crypto exchanges require you to verify your identity for accessing all its trading features – which could take several days to weeks for successful verification.

Market Liquidity

Liquidity could be another critical factor to consider if you are buying and selling in extremely large quantities. With a lack of liquidity, you will not be guaranteed to be filled for the price you demanded. Having that said, with feeble market movement, you can easily generate some profit from arbitrage, given you are quick and persistent in your actions. Generally speaking, the bigger exchange, the higher liquidity. For that reason, crypto exchanges like Binance are recommended for cryptocurrency arbitrage trading.

Reputation

Never blindly register with an exchange without understanding the customers’ experience. Go through several reviews from any legitimate portals and make sure that the majority of the reviews are positive towards the exchange. For highly rated customer experience, please visit our guide of User-Friedly Exchanges List here.

Where do I find Crypto Arbitrage Opportunities?

With a wide collection of cryptos and exchanges, finding cryptocurrency arbitrage opportunities can be a tedious task. However, there are websites and apps that present crypto arbitrage opportunities across exchanges and coins. Using these portals reduces the efforts for finding opportunities and helps us filter the best opportunity that could yield the highest profit. Bots like Empirica are dedicated to seeking such opportunities.

How Does Crypto Arbitrage Work?

Now, let’s look at things from an organized perspective. The working of crypto arbitrage is simple and intuitive. Following is a detailed step-by-step process to arbitrage using cryptos:

  • Step 1: Decide on the cryptocurrency you want to arbitrage. Verify whether the cryptocurrency is available on at least two exchanges. You will obviously need to have an account in the exchanges you will be arbitraging.
  • Step 2: Learn about the price of the cryptocurrency on both the exchanges and compare the volumes between the two. Also, understand the correlation between the rate at which the prices are changing.
  • Step 3: Determine the existence of an opportunity for that cryptocurrency by evaluating the difference between the prices.
  • Step 4: Find the exchange offering the cryptocurrency for a relatively lower price and execute a buy order.
  • Step 5: Transfer the bought crypto to the second exchange (where the price is relatively higher).
  • Step 6: Trigger a sell order on the second exchange.
  • Step 7: Repeat step 2 to step 6 until the difference in prices equalizes or becomes insignificant.

Note: All the transactions, including buying, selling, and transferring, must happen spontaneously. Furthermore, double-check that the price is higher on the second exchange while selling the cryptocurrency.

This ad promotes cryptocurrency within the EU (by eToro Europe Ltd. and eToro UK Ltd.) & USA (by eToro USA LLC); which is highly volatile, unregulated in some EU countries and the UK., no EU consumer protection. Investments are subject to market risk, including the loss of principal.
This ad promotes cryptocurrency within the EU (by eToro Europe Ltd. and eToro UK Ltd.) & USA (by eToro USA LLC); which is highly volatile, unregulated in some EU countries and the UK., no EU consumer protection. Investments are subject to market risk, including the loss of principal.
This ad promotes cryptocurrency within the EU (by eToro Europe Ltd. and eToro UK Ltd.) & USA (by eToro USA LLC); which is highly volatile, unregulated in some EU countries and the UK., no EU consumer protection. Investments are subject to market risk, including the loss of principal.
This ad promotes cryptocurrency within the EU (by eToro Europe Ltd. and eToro UK Ltd.) & USA (by eToro USA LLC); which is highly volatile, unregulated in some EU countries and the UK., no EU consumer protection. Investments are subject to market risk, including the loss of principal.

What are the different ways Crypto Arbitrage can be done?

In Crypto Arbitrage, there are several types. However, only a few of them are extensively used. Following are three popular ways to arbitrage with cryptocurrency:

Regular/Simple Arbitrage

Simple arbitrage refers to buying and selling of the same cryptocurrency at two different exchanges. It is a typical technique to do crypto arbitrage as discussed in the previous section.

Triangular Cryptocurrency Arbitrage

Triangular arbitrage is different from that of regular arbitrage in the number of assets considered. Going by the name, triangular arbitrage involves buying and selling of three cryptocurrencies. Just like how the triangle is made by connecting three vertices, this type of arbitrage works similarly – the first crypto is traded to the second one, the second crypto is traded to the third one, and the third crypto back to the first one. Also, triangular crypto arbitrage is typically done on the same exchange.

Steps involved in performing triangular cryptocurrency arbitrage:

1. Identify three cryptocurrencies and their prices.

2. Decide on the base currency – the currency you would want the investment and profit to be reflected in.

3. Determine if there exists an arbitrage opportunity using the below formula:

A/B x B/C x C/A = 1

Where:

A is the base currency (cryptocurrency)

B and C are counter currencies (cryptocurrencies)

An arbitrage opportunity exists only if the above equation is not equal to 1.

4. Assuming that an arbitrage opportunity exists, the first execution step is to buy the first crypto pair (A/B). In essence, B is sold to acquire A.

5. At the same time, the acquired A is sold to buy C.

6. Finally, the bought C is used (sold) to buy back B. And with arbitrage, you would have received more units of B than you had initially.

Below is an example to understand the above procedure:

Let the three assets taken into account be BTC, ETH, and USD.

Price of BTC/USD = 31,500

Price of ETH/BTC = 0.03085

Price of USD/ETH = 0.00093

To verify if triangular arbitrage opportunity exists, the prices of the three pairs are multiplied, as shown:

BTC/USD x USD/ETH x ETH/BTC = ?

31,500 x 0.00093 x 0.03085 = 0.90375

Since the product is not equal to 1, an arbitrage opportunity exists.

Firstly, BTC is acquired by selling USD. Assuming $10,000 were sold, then we would receive an equivalent of 0.31746 BTC*

*If 31,500 USD = 1 BTC, then

10,000 USD = [(10,000 USD x 1 BTC) / 31,5000 USD] = 0.31746 BTC

The acquired BTC is instantly sold to buy ETH. Using the given rate of ETH/BTC, the quantity of ETH that can be bought is 10.2904**.

**If 0.03085 BTC = 1 ETH, then

0.31746 BTC = [(0.31746 BTC x 1 ETH) / 0.03085 BTC] = 10.2904 ETH

Finally, the 10.2904 ETH is sold to buy back USD. Given the market price of USD/ETH, we would receive a total of 11,064 USD***.

***If 0.00093 ETH = 1 USD, then

10.2904 ETH = [(10.2904 ETH x 1 USD) / 0.00093 ETH] = 11,064 USD

The difference between the USD obtained after selling ETH and the initial USD sold to buy BTC determines the trade’s profit.

Profit = $11,064 – $10,000

Profit = $1,064

Note: The example discussed is an ideal one without considering the fee incurred. However, we would highly recommend you calculate the net profit (fees deducted) that can be made before getting into the trade.

Cryptocurrency Arbitrage and Fees

Fees are another vital point of consideration apart from profit. Especially as arbitraging involves the execution of trades and the transfer of funds in every opportunity, the overall fees could slow the growth of your account in the long term. Here are some different types of fees that a trader would come across while arbitraging, and you must be aware of.

Transaction fee

In cryptocurrency trading, there are typically three types of transaction fees – fixed fee, maker fee, and taker fee. The fixed fee, as the name suggests, is constant irrespective of the asset and volume. A taker fee is paid if you want to instantly execute the trade, while a maker fee is paid to match your expectations with the market condition.

Deposit & Withdrawal fee – Fiat

To trade in an exchange, you need to first deposit money from your bank account to the trading account. And exchanges charge some fee to make this deposit. The deposit fee varies from the deposit amount and type. Similarly, a withdrawal fee applies to transfer fiat funds from the trading account to your bank account.

Deposit & Withdrawal fee – Cryptocurrency

Usually, there is no fee for cryptocurrency deposits and withdrawals. However, in some rare cases, you will be asked to pay some deposit/withdrawal fee.

A Complete Simple Arbitrage Example – Bitcoin (BTC)

We have chosen Bitstam and Binance as our two exchanges for arbitraging.

The price of BTC in both the exchanges are as shown:

Bitstam

Bitstam bitcoin price

Binance

Binance bitcoin price

Since there is a price difference between the exchanges, there exists an arbitrage opportunity.

Let us take scenarios – one without fees and other with fees.

Case 1: Without fee

Exchange 1Exchange 2
Exchange nameBitstamBinance
BTC price$37,839.66$37,902.89
Fiat deposit fees (%)0
Exchange fees (%)00
Bitcoin withdrawal fees (in BTC)0
Bitcoin deposit fees0
Fiat withdrawal fees (%)0
Invested quantity (in BTC)1
Estimated revenue$37,903
Invested money$37,840
Profit/loss$63
Simple Bitcoin Arbitrage Calculator

Inference

When the fees are not taken into account, the profit is simply a multiple of the difference between the two prices. As a result, the profit on this trade would be $63 ($37,930 – $37,840) when exactly one BTC is invested.

Case 2: With fees

Exchange 1Exchange 2
Exchange nameBistam Binance
BTC price$37,839.66$37,902.89
Fiat deposit fees (%)0.02
Exchange fees (%)0.250.25
Bitcoin withdrawal fees (in BTC)0
Bitcoin deposit fees0
Fiat withdrawal fees (%)1
Invested quantity (in BTC)1
Estimated revenue$37,329
Invested money$37,840
Profit/loss-$511

Inference

It can be ascertained that when fees come into the picture, the trade puts you in a loss of $500, despite the price being about $60 higher in the second exchange.

We learn that fees play a major role in determining the profit/loss in an arbitrage trade. Also, the difference in the prices is another critical factor to keep on. Since fees usually remain more or less the same, our main focus must be on the prices between exchanges. A difference of few dollars is insufficient to generate profit; in fact, it would not even leave you at breakeven.

Thus, once you find an arbitrage opportunity, we recommend you use the Simple Bitcoin Arbitrage Calculator and key in the values to verify if it would yield profits or not, before executing the trade.

Pros of Crypto Arbitrage Trading

There are a number of advantages of crypto arbitrage if you know to do it well. Let us shed light on some pros of cryptocurrency arbitrage.

Crypto market is relatively less liquid

The cryptocurrency market is still in its development stage. As a result, liquidity is less compared to other developed markets like forex and equity. The lack of liquidity can be seen as an advantage to arbitrage, due to the irregularities between exchanges.

Cryptos are highly volatile

It is a known fact that cryptos are the most volatile markets in the world. Whatever be the reason for its high volatility and price fluctuations, traders can observe massive price differences between exchanges – giving an opportunity to arbitrage.

Many assets and exchanges to choose from

There are thousands of cryptocurrencies in the market and counting. Besides, there are almost 500 cryptocurrency exchanges functional presently. Many crypto assets and exchanges create a wide range of opportunities for arbitrage in the cryptocurrency market.

Quick Profits

Unlike short-term trading and investing, arbitrage trades can be completed within minutes. Hence, profits can be made at a much faster rate. Arbitrage can be related to scalping when it comes to buying and selling.

Cons of Crypto Arbitrage Trading

Fees

Fees would definitely top the list in the cons section of crypto arbitrage. The different fees, including transaction fee, deposit/withdrawal fee, significantly affect the profit margin on the arbitrage. Hence, it is relevant to find only those opportunities where the price difference is considerable.

Coins become vulnerable to hacks

Arbitrage requires you to have multiple exchanges, where you will need to store your coins across different exchanges. Since the coins are stored in an online platform, your coin by default becomes susceptible to hacks. And there have already been cases of exchange hacks in the past.

5/5

As with any asset, the value of Digital Currencies can go up or down and there can be a substantial risk that you lose money buying, selling, holding, or investing in digital currencies.

5/5

This ad promotes cryptocurrency within the EU (by eToro Europe Ltd. and eToro UK Ltd.) & USA (by eToro USA LLC); which is highly volatile, unregulated in some EU countries and the UK., no EU consumer protection. Investments are subject to market risk, including the loss of principal.

Conclusion

The ability to arbitrage in the market looks simple and interesting. Unlike trading, arbitraging does not involve the analysis of charts and patterns to predict the markets. Initially, traders might see the act of arbitrage as a math-oriented concept, which indeed is true to an extent. However, all it requires is basic mathematics and experience.

Arbitrage is less rewarding but is definitely not as risky as margin trading and speculation. But lack of perfection and timing in this field can cause serious effects to one’s account.

Bitcoin and altcoins are still developing – due to which there is less liquidity and high volatility. But, with the increase in the population of participants in this market, the price gap between exchanges will begin to narrow, and eventually reduce the opportunities to arbitrage.

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