Key Takeaways
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Crypto arbitrage is a low-risk and profitable trade that takes advantage of price differences for the same cryptocurrency on different exchanges or trading platforms.
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There are many different types of arbitrage strategies, from cross-exchange arbitrage to interest rate arbitrage, know the various strategies to decide on your arbitrage strategy.
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Arbitrage trading comes with various considerations such as timing, fees, and more which can affect how profitable you are.Understand these considerations to be a better arbitrager.
There’s no shortage of cryptocurrency enthusiasts touting how you can make money by investing in crypto.Hodling
Bitcoin, trading bots, dollar-cost averaging, and arbitrage are some of the many strategies.
But if the word “arbitrage” is new to you, you might wonder, what is arbitrage trading in crypto and how does it work?
Crypto arbitrage is a relatively low-risk way to make money, with the simplest strategy being buying an asset at a lower price on one exchange and selling it for a higher price on another.However, fast transactions are crucial, and large profits typically require significant capital.
What Is Arbitrage Trading?
Arbitrage trading is the process of buying an asset for a lower price on one cryptocurrency exchange and immediately selling it for a higher price on a different exchange.The difference between the higher and lower buy-in price is your profit.
The concept of arbitrage has been around for many years in traditional markets.But cryptocurrency offers unique arbitrage trading opportunities because the market stays open 24/7.Moreover, some people even have access to trading on crypto exchanges in multiple parts of the world.
However, depending on your country of residence, being able to trade on every exchange isn’t a given.That’s one of the reasons that crypto arbitrage opportunities happen.
For example, South Korea’s strict crypto policies prevent citizens from moving lots of money out of their country.
They also don’t allow foreigners to invest in South Korean cryptocurrency exchanges.
As a result, the price of any given crypto asset on South Korean exchanges is often higher than in other parts of the world.It’s such a common occurrence that there’s even a name for it—
Kimchi premium.
This presents a profitable arbitrage as, if a South Korean buys a crypto asset on another (international) exchange, they can send it to a South Korean cryptocurrency exchange and often sell it for a profit.
Other scenarios that create crypto arbitrage opportunities include:
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Exchange lag time
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Favorable transaction and transfer fees
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Different price reaction times across exchanges
Approximately
500 cryptocurrency exchanges exist in the world.Each exchange has its own order books, and the price of an asset on any given platform depends on the most recent bid-ask matched order.
So, although the price discrepancy among exchanges is often minor, they sometimes have lag times or vary in their price reaction times according to the interest of the investors on their platform.
You might encounter lucrative crypto arbitrage opportunities if you work with high-volume trades and qualify to sign up for exchanges offering competitive transaction and transfer fees.
Is Crypto Arbitrage Profitable?
Can you make money with crypto arbitrage? Crypto arbitrage can be profitable, but given that the price difference in exchanges is usually tiny, this trading strategy is most profitable when you have a large sum of money to invest, and also have access to arbitrage bots.
For example, let’s say you purchase
bitcoin for $25,000 on Kraken and sell it for $25,300 on Binance.
If you invest $25,000, you’ll receive a $300 profit minus exchange and Bitcoin transaction fees.But if you invest $1,000, you’ll only make $12.
Even though using an arbitrage strategy is relatively low risk, low risk often comes with lower rewards.So, people with less capital might not feel that the money they can earn from crypto arbitrage is worth the effort.
Types of Arbitrage Trading Strategies
It’s possible to use arbitrage trading strategies across centralized and
decentralized exchanges.
But the process looks different on the backend, given that trading arbitrage on centralized exchanges involves waiting for your order to be filled via an order book.In contrast, decentralized arbitrage trades execute right away since you’ll buy and sell a crypto asset already in a liquidity pool.
How do you make money with crypto arbitrage? Below are some of the most popular types of crypto arbitrage trading strategies.
For the sake of simplicity, we’ll use bitcoin as the crypto asset in most of our examples.
Cross-Exchange Arbitrage
Using the cross-exchange method is the classical type of arbitrage.In this case, you’ll identify bitcoin selling for a lower and higher price across two different exchanges.
You’ll then purchase bitcoin at a lower price and sell it at a higher price, keeping the profits.
Profitable arbitrage trading can also be done on perpetual contract positions as well, and not just for
spot positions.
As perpetual contracts allow for leverage, which comes with a liquidation price, during periods of volatility, an exchange with lower liquidity and a big liquidation can cause the price of bitcoin to move more drastically compared to other exchanges, and an arbitrage trader can capture this difference to earn a risk-free profit.
For example, on exchange A, a large liquidation has occurred, and the bitcoin perpetual contract price goes to $19,900, but on exchange B, the bitcoin perpetual contract is only at $20,000.An arbitrage trader will long bitcoin on exchange A at $19,900 and short the same amount of bitcoin on exchange B at $20,000 to remain delta-neutral.When the volatility subsides, the prices of both exchanges should equalize, and the arbitrage trader should have a net profit from both positions.
Spot, Perpetual and Futures Arbitrage
During periods of volatility and huge liquidations, bitcoin prices between spot, perpetual, and futures can diverge larger than during normal market conditions.
An arbitrage trader could take advantage of the price difference of bitcoin between the different markets to make money without risk.
For example, on exchange A, a large short liquidation has occurred, and the bitcoin perpetual contract price goes to $20,000, but its spot price is only at $19,900.
An arbitrage trader will buy bitcoin at $19,900 and short bitcoin at $20,000 to remain delta-neutral.When the volatility subsides, the prices of both markets usually equalize or go back to their standard differences, and the arbitrage trader should have a net profit from both positions in the end.
The same principle can apply with futures contracts when a larger and normal deviation occur between spot and futures prices due to futures liquidations.
Spatial Arbitrage
Spatial arbitrage follows the same concept as cross-exchange arbitrage.
The difference is that you’ll buy and sell your crypto using exchanges in two different parts of the world.
The example we shared about the Kimchi premium in South Korea showcases how spatial arbitrage works.Apart from South Korea, spatial arbitrage is also often used with South African exchanges, which are also limited by regulations and often have prices that are higher than market rates.
Interest Rate Arbitrage
Many cryptocurrency exchanges offer borrowing and lending options to their users.However, the interest rates they offer often vary.This means you can borrow an asset like bitcoin at a low-interest rate from one exchange and then lend it for a higher interest rate on another.
A large interest rate difference is usually more common for decentralized money markets in developing DeFi ecosystems such as
Cosmos, as market participants may be less efficient.
For example, the ATOM borrow APR on
Umee, a Cosmos’ money market is around 4.65%, whereas the ATOM lending APR on Nitron, also a Cosmos’ money market is around 7.11%, presenting an interest rate arbitrage between the two assets.
Image taken from Nitron,
Demex
Note: These are examples; CoinGecko is not endorsing these protocols or recommending this particular interest rate arbitrage.Please perform due diligence before performing any arbitrage.
Bot Arbitrage
Arbitrage trading can take a lot of time because you have to compare prices on different exchanges.
On top of that, price differences are usually gone by the time you attempt to manually arbitrage them.But if you use a bot program, your bots can find arbitrage opportunities and do the work for you faster than you can physically.
We’ll discuss the bot arbitrage strategy and its profitability in more detail shortly.
Statistical Arbitrage
Bots use statistical arbitrage, but some traders with a background in designing or reading mathematical models may choose a personalized, statistical approach to arbitrage trading.
Python is a popular tool for algorithmic arbitrage trading.
Doing so opens the potential opportunity for more arbitrage trades.However, this skill takes time, which is why many people rely on bots.
Triangular Arbitrage
Triangular arbitrage involves buying and selling three or more cryptocurrencies for profit without having to leave an exchange.
Such a method is ideal for people with limited cryptocurrency exchange choices due to their country of residence.
The basic idea behind triangular arbitrage is to convert one crypto to another, then to a third, before converting back to the original crypto.If the exchange rates between the different crypto pairs are not proportional, there may be an opportunity to make a profit.
An example of triangular arbitrage in crypto is buying bitcoin and exchanging it for
Litecoin and Solana before converting Solana back to bitcoin and taking advantage of price discrepancies along the way to net you more bitcoin if the arbitrage trade works in your favor.
Decentralized Exchange Arbitrage Example
Arbitrage on decentralized exchanges is accomplished through the use of liquidity pools rather than order books.That means people can automatically buy and sell their crypto assets, given that a pool of those assets is already in waiting.
Assets on a decentralized exchange vary in pricing according to the people who provide liquidity by voluntarily placing their crypto assets in a pool.A constant product curve formula ensures the ratio of assets and their pairing remain balanced.
Choosing between
decentralized and centralized exchanges can be tricky, but it will be case-specific and depend on your needs.
But when a large buyer swoops in, it can offset the price of the purchased asset and the coin paired with it.
The decentralized
MakerDAO is one example.MakerDAO operates on the Ethereum blockchain and provides liquidity to its users through its stablecoin, DAI.
So, if you want to buy DAI from a DAI/BTC pool, you’d have to deposit (sell) bitcoin (BTC) into the pool to be able to remove (obtain) DAI.The result is that there will be more BTC in the pool than DAI.
BTC’s price on the decentralized exchange will decrease and DAI price will increase automatically due to the formula.The result is that more people will want to buy BTC, adding more DAI to the pool until the prices stabilize with the DAI and BTC’s prices on other exchanges.
In the meantime, arbitrage traders—including those that changed the ratio of the pool by making a large DAI purchase, can profit from the price differences before the prices on the decentralized exchange are equalized with centralized exchanges again.
This type of decentralized exchange arbitrage is especially common during periods of volatility as large liquidations can happen on decentralized exchanges, which will lower the price of an asset, presenting a profitable arbitrage opportunity.
Arbitrage Trading Considerations
Although it might seem like you can make money by using arbitrage trade crypto strategies, the reality is that many factors could hinder your profits.
Some of the most essential items to know when considering the arbitrage technique include:
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Slippage can happen
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Fees can eat into profits
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Low volume can delay trades
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Blockchain transaction speeds vary
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The cryptocurrency market is volatile
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Exchanges or bots could go offline
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Anti-money laundering checks cause delays
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Requires high bankroll for significant profits
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Security risks by keeping money in an exchange
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You may not have access to all arbitrage opportunities
Our goal in sharing this isn’t to make you run away from arbitrage but to consider whether it’s the best crypto trading strategy for your situation.
Below are details about some of the key takeaways of these points.
Timing Is Everything
The crypto market is notorious for being volatile, and since it’s open 24/7, there’s always the potential for a massive spike or drop.So, you could get unlucky and buy a crypto asset, and the market could plunge before you have time to exit your arbitrage trade in profit.
Another timing issue is the delay that sometimes happens to make a transaction on blockchains.Some crypto blockchains execute trades within seconds.Others, such as Ethereum, experience periods of network congestion and high gas fees during periods of volatility where large arbitrage opportunities are present.
So, suppose you choose to trade a cryptocurrency with slower average transaction times or at a time when the network has a lot of traffic.In that case, you could lose a profitable arbitrage trade while waiting for your buy or sell order to process.
Prices and Fees
Since the profit margin is typically so low in arbitrage trading, every fraction of a coin counts in your buy and sell trades.
Slippage is the concept of your buy or sell order executing at a different price than you anticipated, which is especially the case when trading on decentralized exchanges that does not allow for limit orders and every trade is a market order that moves the price.Slippage can make a trader lose some or all of their potential profits from arbitraging.
An exchange’s fees can also make a dent in your profits.
If you’re not careful, you could even lose money from arbitrage trades due to higher than expected exchange fees.
High fees are the most common consideration for low-volume traders, as most centralized exchanges operate on a tiered system, offering lower trading fees according to their 30-day trading volume.And that doesn’t even include the blockchain transfer fees you’ll need to pay by transferring crypto coins between exchanges.
It’s easy for newbies to miscalculate or underestimate the cost of exchange fees.
For this reason, a bot can be helpful, as they typically factor in the anticipated cost of fees before choosing to execute a trade.
System Errors
Technology isn’t perfect.
So, you can expect your arbitrage bots or cryptocurrency exchanges to occasionally have system errors, temporarily shutting their doors to trading.
Such a situation often happens during periods of high trading traffic.Unfortunately, this can correspond with an abundance of profitable trading situations.A cryptocurrency exchange might also temporarily halt trading a specific asset if they notice a significant price discrepancy on their platform compared to the broader market.
Is Crypto Arbitrage Legal?
Arbitrage trading with crypto is legal in most parts of the world.
The key is to trade between cryptocurrency exchanges that you can legally sign up for if you use an arbitrage strategy involving different platforms.
For example, due to strict cryptocurrency laws, South Koreans would have trouble implementing many of the arbitrage trading strategies discussed here if they involve crypto exchanges outside their country.
Americans also have limited access to cryptocurrency exchanges, given that the United States doesn’t license exchanges offering derivatives trading to the everyday investor.Nevertheless, it’s often still possible for people from countries with tighter crypto regulations to perform certain arbitrage trades.
Are Crypto Arbitrage Bots Profitable?
A crypto arbitrage bot can be profitable, but due diligence is essential to ensure the bot has a history of high performance.
The advantage of using
cryptocurrency bots for arbitrage is that they can watch the entire cryptocurrency market simultaneously.They can also buy and sell a crypto asset faster than humans.
Therefore, you can often make more money with a well-functioning bot since the trades happen near-instantly.You can also expect a bot to perform more trades since they can spot them quickly, making them potentially more lucrative for people trading with a small amount of capital.
That said, all technology can malfunction or be exploited.Recently,
3Commas, a popular crypto bot platform was hacked, leaking API keys which resulted in the loss of many traders.So, you need to be comfortable with the risks of letting a bot manage whatever amount of money you permit it to trade with.
Platforms/Apps for Crypto Arbitrage
If you’re ready to try crypto arbitrage, below are some platforms and apps worth considering.
Pionex
Pionex defies the saying, “You have to spend money to make money,” because they offer a free arbitrage bot.
Of the 16 bots that Pionex provides, they offer a free arbitrage bot that they call “Moderate Mode.” According to Pionex, their
bot averages an annualized rate of return between 5% to 50%.You can use Pionex on your desktop and via an app on your mobile device.
Cryptohopper
Cryptohopper is on the expensive side for a bot, but it comes with high ratings and excellent resources for people new to crypto arbitrage.
Furthermore, they have a system called Exchange Arbitrage, which allows your bot to identify and jump on arbitrage opportunities from several different exchanges without you having to transfer a crypto asset between them.
Coinrule
Coinrule is a more advanced bot while still being friendly for beginners.It allows you to set up and automate an arbitrage strategy without coding experience.
You’ll be able to link your Coinrule account to multiple exchanges, such as Coinbase Pro, Binance, and Poloniex.
Final Thoughts
The answer to “What is crypto arbitrage?” is more nuanced than the uninitiated might expect, given that several arbitrage trading strategies exist.
Some crypto arbitrage traders might spend their days at their computers monitoring exchanges for price discrepancy opportunities, but nowadays most of the profitable arbitrage traders are believed to use bots to automate the process and remain competitive.
While arbitrage trading with crypto can be profitable and is less risky than certain other crypto investment strategies, there’s still potential for you to lose money.
So, we recommend that you do your research before deciding if this trading method is right for you.
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