Crypto arbitrage trading and how does it work?

Crypto arbitrage is a low risk process where cryptocurrency traders and investors exploit price differences of digital assets across various exchanges to make profits.

Having been a mainstay in the stocks and traditional financial market, the crypto market has provided more opportunities for arbitrage trading possibly due to the high volatility of these assets or due to the wide variety of exchanges available for trading cryptocurrencies. In this article, we’ll take you through all that crypto arbitrage entails; who knows, you may just consider quitting your job after going through this.

What is crypto arbitrage?

As already established, crypto arbitrage is a low risk trading strategy where cryptocurrency investors and traders take advantage of price differences of digital assets across various exchanges to make profits. In simple words, it involves buying a particular cryptocurrency on exchange ‘A’ and selling it at a slightly higher price on exchange ‘B’.

The entire process of crypto arbitrage trading is easy and can be completed by individuals who are not expert traders. Also, it is inexpensive and in most cases these trades can be carried out by a newbie trader who typically just trades with a smartphone or any device that can easily access exchange websites or mobile apps.

As much as arbitrage trading is an easy and low risk trading strategy, it involves proper research to carefully identify these arbitrage opportunities. The image below shows the price variation of ‘bitcoin’ across various exchanges. In a case like this, there is a slight arbitrage opportunity because a trader can easily buy from ‘Coinbase exchange’ and sell on ‘FTX’ at low risk for very little profits.

How does cryptocurrency arbitrage work?

Cryptocurrency arbitrage involves exploiting price differences of certain digital assets across various exchanges to make profits. If prices differ for a particular digital asset across two different exchanges, there is an opportunity for arbitrage trading.

In the image above, there is an arbitrage opportunity for bitcoin due to the price difference of bitcoin across Coinbase exchange and FTX. An arbitrageur in this case can buy bitcoin for $19,939.41 on Coinbase exchange and quickly sell for $19,952 on FTX making a profit of $12.59 per unit of bitcoin without factoring in the transaction fees.

In most cases, the best and most profitable arbitrage opportunities exist for newly listed digital assets. This is so because of differences in listing time and trading volumes across various exchanges.

Different types of crypto arbitrage strategies

Arbitrage trading can be executed on both centralized and decentralized exchanges with both having their differences. Trading on centralized exchanges involves waiting for orders to get filled via an order book while trades on decentralized exchanges are executed immediately from an already existing liquidity pool through the use of smart contracts.

Some of the popular crypto arbitrage strategies are:

Cross-exchange Arbitrage

Also known as simple arbitrage, cross-exchange arbitrage as the name implies involves buying cryptocurrencies on one exchange and quickly selling on another. As different markets exist for a particular cryptocurrency, it is possible to exploit the price difference in each of these markets. An example of this is shown in the bitcoin market image above where an arbitrageur can buy bitcoin for $19,939.41 on Coinbase exchange and quickly sell for $19,952 on FTX. 

Few problems with this strategy are high cost of transaction fees and delay in transferring from one exchange to another during which time the arbitrage opportunity may disappear.

Spatial Arbitrage

This is a more advanced form of cross-exchange arbitrage which involves making use of exchanges in two different regions. This capitalizes on the demand and supply of a particular digital asset in two different regions at a particular time. 

A notable example of this is when Sam Bankman-Fried exploiting the Kimchi Premium bought bitcoin for $10,000 in the US and sold it for $15,000 in Korean exchanges.

Triangular Arbitrage

Triangular arbitrage involves exploiting the price difference between three cryptocurrencies in a particular exchange. This option is ideal for traders with limited choice of exchanges due to their region of residence. An example of this is when a trader trades bitcoin for BNB (BTC/BNB), then trades the BNB for ether (BNB/ETH) and finally trades the ether for bitcoin (ETH/BTC). 

If there is a discrepancy in the price of any of the three trading pairs, the trader will end up with more bitcoin after the completion of the trade. All these are executed in one exchange and traders do not have to pay any fees for transfer from one exchange to another.

Decentralized Arbitrage

In some cases, arbitrage opportunities can exist between centralized and decentralized exchanges. This is made possible when there is a discrepancy between the price of a particular asset on a decentralized exchange which makes use of smart contracts and a centralized exchange which makes use of order books. 

In cases like this, an arbitrageur can take advantage of these discrepancies and execute a cross-exchange arbitrage between a centralized and decentralized exchange.

Statistical Arbitrage

This involves the use of bots and computational mathematical models to execute arbitrage trades and maximize trades. This method makes use of trading bots to automate high volumes of trades in short time frames.

Interest Rate Arbitrage

Many exchanges offer borrowing and lending options to their users with varying interest rates. So, a trader can borrow an asset like bitcoin from an exchange with a low interest rate and lend it out on another exchange with a higher interest rate.

Benefits of cryptocurrency arbitrage

Some of the advantages of using crypto arbitrage as a trading strategy are:

It Is Less Risky

Compared to HODLing cryptocurrencies or trading futures, exploiting arbitrage opportunities is less risky and hardly results in loss of significant funds. In most cases, arbitrage is executed in a matter of seconds or minutes and does not provide enough time frame for significant price change even in a market with high volatility as seen in the crypto market.

Unlike HODLing, which ties up liquidity for a long period of time, arbitrage trading is executed in a few minutes and hardly results in loss of funds due to high volatility.

Arbitrage Opportunities Abound

With lots of cryptocurrency exchanges in existence and hundreds of cryptocurrencies listed in each of them, there are lots of options available to explore crypto arbitrage trading.

According to Statista, there are roughly around 10,000 cryptocurrencies in existence as of February 2022. With these cryptocurrencies listed across various exchanges with varying trading volumes, it provides various opportunities to exploit arbitrage.

Requires Little to No Trading Knowledge

Crypto arbitrage trading is quite easy to execute and requires little to no trading knowledge. This means that even a newbie crypto trader with very little knowledge of trading can execute arbitrage trades and make profits.

This method of trading is cheap, easy and hardly requires any market prediction knowledge on the part of the trader. It in most cases only requires research to identify arbitrage opportunities and access to varying options of crypto exchanges for arbitrage trade execution.

Disadvantages of crypto arbitrage

Having seen the appealing part of crypto arbitrage, it is also important to note that it comes with its own risks and challenges no matter how small. Some of the challenges associated with this method of trading are:

High Transaction Fees

High transaction fees are a problem and can sometimes eat into a traders’ profit or in some cases even result in losses. This is a major problem with cross-exchange and decentralized arbitrage where arbitrage opportunities exist between two different exchanges.

A proper example would be using ETH which has a high gas fee compared to other cryptocurrencies like BNB and Matic. Arbitrage opportunities involving cryptocurrencies with high transaction fees need to be properly calculated before execution to avoid losing funds to payment of transaction fees.

Transaction Delays

While trying to explore an arbitrage opportunity, it is important to note that a delay in transaction can hinder the success of an arbitrage trade because most arbitrage opportunities only last for very few minutes.

Having established this, a very small discrepancy in the prices of assets like bitcoin and ethereum across two different exchanges may hardly be exploited due to the delayed speed of transaction in their blockchains.

Regional Differences and KYC Regulations

Different regions have different laws and policies and these consequently affect the opportunities that abound in crypto arbitrage trading. Some exchanges are only available to people of a particular region and it makes it impossible for people who do not stay in that region to exploit arbitrage opportunities when they occur.

Also, most exchanges enforce Know you customer (KYC) regulations before assets can be transferred to other exchanges. This simply means that a trader who’s yet to complete KYC verification cannot exploit arbitrage opportunities when they occur.

Is cryptocurrency arbitrage still profitable today?

Crypto arbitrage is a low risk trading method that exploits price differences across two or more different markets. This in most cases is dependent on the listing time and trading volume of a particular asset across various exchanges. While it has become quite difficult to find cryptocurrencies with wide arbitrage margins, it is possible to make profits from arbitrage with low risk of capital loss.

Making significant profits from arbitrage trading also depends on the amount of capital used. In the bitcoin market image shared above, the price difference of bitcoin across Coinbase exchange and FTX is $12.59. While this amount is insignificant, big traders or investors can exploit that arbitrage opportunity with about 1,000 units of bitcoin thereby making profits of over $12,000. This shows that even with slight price discrepancies, significant profits can still be made.

Making profits from arbitrage trading requires proper research. Two techniques for finding arbitrage opportunities are:

Newly Listed Coins/Tokens

Newly listed cryptocurrencies offer the best opportunities for arbitrage trading due to differences in trading volume at the time of listing. A lot of traders exploit arbitrage for newly listed coins for a while before market correction. 

If a cryptocurrency is currently trading for $2 on exchange A and is having a second listing on exchange B, the price of the assets across exchanges A and B will most likely vary as the asset will see a spike in price in exchange B due to increased buy volume. In this case, arbitrage traders can quickly buy from exchange A and sell on exchange B before market correction.

Trading Volume Difference

Different exchanges have different trading volumes for different digital assets. This trading volume influences the price of cryptocurrencies on each of those exchanges. The price of a particular asset on an exchange with lower trading volume will most likely be less than the price of the same asset on an exchange with higher trading volume. 

This provides an opportunity for arbitrage trading. A risk associated with this is that it may take a long time for orders to get filled when the exchange has low trading volume.

How to begin crypto arbitrage trading

To make profits from crypto arbitrage, a trader must have access to a variety of cryptocurrency exchanges so as to easily exploit cross-exchange arbitrage. Knowledge of the use of decentralized exchanges can also be beneficial as it makes it possible to exploit arbitrage opportunities when they arise in decentralized exchanges.

Arbitrage traders need to make sure there is available capital at all times so as to quickly exploit these opportunities when they arise. Another important factor to take into consideration is the speed of execution. Most arbitrage opportunities last for only a few minutes and traders can easily miss out on them given the short amount of time they exist.

Due to the short amount of time these opportunities exist, it is difficult to complete most arbitrage trades without the use of trading bots. Trading bots maximize profits by executing high volumes of trade in the shortest possible time.

Where to do arbitrage trading

In addition to using bots, certain platforms and apps can be used to automate the process of finding and exploiting price discrepancies across multiple exchanges. These easy to use platforms offer an opportunity for low risk traders to make profits through crypto arbitrage. Some of these platforms include:

Arbismart

Arbismart is a fully EU regulated, automated system, which claims to scan up to 35 exchanges at once. According to Arbismart, their platform generates annual returns of up to 45% depending on the size of the investment. An interesting point to note is that the Arbismart platform is readily accessible on the go using a laptop, tablet or mobile device.

Cryptohopper

Cryptohopper provides an automated platform that capitalizes on price inefficiencies to make profits for users. It can be utilized for cross-exchange arbitrage and triangular arbitrage. Users can also simply connect different exchanges where they have funds and have Cryptohopper search for arbitrage opportunities.

Pionex

Pionex is a cryptocurrency exchange which offers 16 free trading bots. Of the 16 trading bots, Pionex offers a free arbitrage bot known as ‘moderate bot’ which according to them has an annual return rate of about 5% to 50%. The platform is also readily available on the go and can be accessed using a laptop, tablet or through the mobile app.

Coinrule

While being a more advanced trading bot, Coinrule still maintains beginner friendliness. Unlike the other platforms above, Coinrule lets users set up and automate arbitrage strategies without knowledge of coding. After setting up arbitrage strategies, traders can easily link their Coinrule account to different exchanges.

Conclusion

Crypto arbitrage opportunities arise across different exchanges always and this makes it possible for low risk traders to take profits by capitalizing on exchange price inefficiencies.

As promising and less risky as crypto arbitrage may seem, it is important to note that making significant profits off arbitrage requires a decent amount of capital, access to a variety of cryptocurrency exchanges and proper research to identify potential arbitrage opportunities.

For an arbitrageur who wants to make significant profits from discrepancies across asset prices, the use of arbitrage trading bots is quite essential since these bots have a tendency to maximize profits by executing high volumes of trade in the shortest possible time.

(с) The article is written by Ikenna Benjamin, 2022