There are different strategies for trading cryptocurrencies. The best known are those used to trade the cryptocurrency market, such as day traders. Other strategies do not require the high level of experience that day trading requires.
Crypto arbitrage trading is one such strategy that does not require such high-level trading skills. However, it is not “simple” and requires some knowledge of the crypto markets. So how does crypto arbitrage trading work?
What is crypto arbitrage trading?
If you have visited two or more exchanges at 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 all markets, whether they are shares, commodities or metals. It is also present in the cryptocurrency market, hence the rise of cryptocurrency 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 capable of buying and selling crypto assets on exchanges can use to make a profit. It is also usually a low-risk trade that requires little or 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 sell it on exchange B, where the price is slightly higher.
To get a better idea of what we are talking about, visit CoinMarketCap and 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 on Huobi Global and sell on Binance, you will make a profit of about $11 on each Bitcoin.
Keep in mind, however, that as the cryptocurrency market is very volatile, the trade has to be done very quickly, almost simultaneously, before the prices change again. This may not be a problem in some types of arbitrage trading, as we will see shortly.
However, volatility is not all bad as it makes arbitrage trading opportunities more abundant in the crypto market than in any other market.
4 types of crypto arbitrage trading
There are various types of crypto arbitrage, depending on how the arbitration is conducted and the parties involved. The following are the four main types of crypto arbitrage.
1. Arbitrage between exchanges
This is the type of arbitrage trading where you simply buy on one exchange and sell on another. It’s just two exchanges.
Since arbitrage trading of this type relies on real-time asset prices, it is impractical to buy assets on one exchange and transfer them to another exchange to sell.
You can avoid this and transaction fees by buying and selling the asset simultaneously. This is possible if you have assets on both exchanges.
Let’s say you have $20,000 worth of USDT on Binance and 1 BTC on Kraken.
If Bitcoin is worth $20,300 on Kraken but is worth exactly $20,000 on Binance, you can take advantage of this opportunity by buying Bitcoin on Binance with your $20,000 USDT while simultaneously selling Bitcoin on Kraken at $20,300.
Once this is complete, the $300 spread becomes a profit for you, and you will not have to pay withdrawal and deposit fees to move bitcoin from Binance to Kraken or vice versa.
2. Triangular Arbitration
This type of arbitrage trading is a bit easier because it is done on a single exchange, even though it involves three different assets.
Suppose you have Bitcoin, Solana, and Ethereum. If the last two assets are undervalued on the exchange, you can take advantage of this arbitrage opportunity to get more Bitcoin.
For example, you use your Bitcoin to buy Solana, then you use 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 sending Ethereum to another exchange and without paying your high gas fees.
Since everything is done on the same exchange, there are no withdrawal, transfer or deposit fees.
3. Statistical arbitrage
This involves the use of mathematical models to trade assets and profit from price differences. Statistical arbitrage also uses arbitrage bots, which are capable of trading hundreds of assets at the same time.
The bots use mathematical models to predict whether a trade will be a winner or a loser and trade based on the prediction.
Since bots are involved, the process is mostly automated rather than manual, so there’s not much to do. 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 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 with a high demand for Bitcoin, you can buy on an exchange based in another country where the demand for the asset is lower, and sell on local exchanges in your own country.
This will give you an instant profit as the higher demand means that Bitcoin will be worth more. Although this sounds like arbitrage between exchanges, you don’t have to buy and sell based on real-time prices, so you can buy on one exchange and manually transfer to the other to sell for a profit.
Pros and Cons of Crypto Arbitrage Trading
Crypto arbitrage trading has its good and bad sides, unsurprisingly.
- Low risk trading strategy that requires little experience.
- Can be done during low and high volatility
- There are not many fees involved in most arbitrage trades.
- Volatility causes rapid changes in price, which can be challenging in arbitrage between exchanges
- May require assets on at least two exchanges
Is Crypto Arbitrage Trading Right For You?
Crypto arbitrage trading can be quite profitable if done correctly. It also involves very little to no risk, compared to day trading, for example, which involves trading on real market movements.
If you have the assets to trade and meet the conditions for any of the arbitrage trading methods listed above, it is definitely worth a try.
The information on this website does not constitute financial, investment or business advice and should not be considered as such. MakeUseOf does not advise on any trading or investment matters and does not advise the buying or selling of any particular cryptocurrency. Always do your own due diligence and consult a licensed financial advisor for investment advice.