What is crypto arbitrage trading? How does it work?

There are several strategies for trading cryptocurrencies. The most famous are the ones used to trade the crypto market, such as day traders. Other strategies do not require the high level of expertise that day trading requires.


Crypto arbitrage trading is one of these strategies that does not require such high level trading skills. However, it is not “easy” and does require some knowledge of crypto markets. So, how does crypto arbitrage trading work?


What is crypto arbitrage trading?

If you have visited two or more exchanges around the same time, you may have noticed that the price of Bitcoin is not the same on all those exchanges. Instead, the price on one exchange is higher or lower than the other.

This phenomenon is present in every market, be it stocks, commodities or metals. It is also present in the crypto market hence the rise of crypto arbitrage trading.

Crypto arbitrage trading is a crypto trading strategy that involves buying and selling crypto assets and taking advantage of the price difference on competing exchanges to make a profit.

Arbitrage is a strategy that anyone who can buy and sell crypto assets on exchanges can use to make a profit. It is also generally low-risk trading that requires little to no trading experience.

How does crypto arbitrage trading work?

Arbitrage trading is all about buying and selling crypto assets from one exchange to another. Basically you buy Bitcoin on exchange A, where the price is lower, and you sell on exchange B, where the price is slightly higher.

To get a better sense of what we’re saying, go to CoinMarketCapand select Bitcoin to see the differences in price on different exchanges.

At the time of writing, the price of Bitcoin on Binance is $20,141 while on Huobi Global it is $20,130. So if you buy from Huobi Global and sell on Binance, you will profit about $11 on each Bitcoin.

However, keep in mind that since the cryptocurrency market is highly volatile, trading must be done very quickly, almost simultaneously, before prices change again. This may not be a problem with some types of arbitrage trading, as we will see shortly.

However, the volatility is not only bad as it makes the opportunities for arbitrage trading more abundant in the crypto market than in any other market.

4 types of crypto arbitrage trading

There are different types of crypto arbitration depending on how the arbitration is done and the parties involved. Following are the four main types of crypto arbitrage.

1. Arbitration between exchanges

This is the type of arbitrage trading where you simply buy from one exchange and sell on another. It’s just two exchanges.

Since this type of arbitrage trading relies on the real-time prices of assets, it is impractical to buy assets on one exchange and transfer them to another exchange to sell them.

You can get around this and transaction costs by buying and selling the asset at the same time. This is possible if you hold assets on both exchanges.

Let’s assume you own $20,000 USDT on Binance and 1 BTC on Kraken.

If Bitcoin is worth $20,300 on Kraken but exactly $20,000 on Binance, you can take advantage of this opportunity by buying the Bitcoin on Binance with your $20,000 USDT while simultaneously selling the Bitcoin on Kraken for $20,300.

Once this is done, the $300 spread will become a profit for you and you will not have to pay any withdrawal and deposit fees for moving the bitcoin from Binance to Kraken or vice versa.

2. Triangular Arbitration

This type of arbitrage trading is a bit simpler as it is done on a single exchange although it involves three different assets.

Let’s say you own Bitcoin, Solana and Ethereum. If the last two assets in the exchange are undervalued, you can use this arbitrage opportunity to get more Bitcoin.

For example, you use your Bitcoin to buy Solana and then your Solana to buy Ethereum. Finally, you use Ethereum to buy Bitcoin again, and that’s it.

You will end up with more Bitcoin than when you first bought Solana, and without having to transfer Ethereum to another exchange and pay the high gas costs.

Since it’s all done on the same exchange, there are no withdrawal, transfer, or deposit fees involved.

3. Statistical Arbitration

This includes using mathematical models to trade assets and profit from price differences. Statistical arbitrage also uses arbitrage bots, which are capable of trading hundreds of assets simultaneously.

The bots use mathematical models to predict whether a trade will be a winning or losing trade and trade based on the prediction.

Since there are bots involved, the process is mainly automated rather than manual, so you don’t have to do much. This makes it more convenient with less risk of making mistakes.

4. Spatial Arbitration

This type of arbitrage trading takes advantage of differences in the price of an asset based on differences in the geographic locations of each exchange. It is very similar to the arbitration between exchanges, apart from the spatial aspect.

One factor driving spatial arbitrage is differences in demand for an asset. For example, if you live in a country where Bitcoin is in high demand, you can buy from an exchange in another country where the demand for the asset is lower and sell on local exchanges in your home country.

This will make you an instant profit as the higher demand means the Bitcoin will be worth more. While this sounds like inter-exchange arbitrage, you don’t have to buy and sell based on real-time prices, so you can buy from one exchange and manually transfer to another to sell for a profit.

Advantages and disadvantages of crypto arbitrage trading

Crypto arbitrage trading has its good and bad aspects, as you would expect.

Pros

  • Low-risk trading strategy that requires little experience
  • Can be done during both low and high volatility
  • There are not many fees associated with most arbitrage transactions

cons

  • Volatility causes rapid price changes, which can be challenging in inter-exchange arbitrage
  • May require assets on at least two exchanges

Is crypto arbitrage trading right for you?

Crypto arbitrage trading can be quite profitable if done right. It also carries very little to no risk compared to, say, day trading, where actual market movements are traded.

If you have the assets to trade and meet the requirements for the above arbitrage trading methods, it is definitely worth a try.

‚ÄčThe information on this website does not constitute and should not be considered as financial advice, investment advice or trading advice. MakeUseOf does not advise on trading or investment matters and does not advise that any particular cryptocurrency should be bought or sold. Always conduct your own due diligence and consult a licensed financial advisor for investment advice.

Leave a Reply

Your email address will not be published. Required fields are marked *