Cryptocurrency arbitrage trading is smartly taking advantage of the crypto price difference between two or more crypto exchanges.
Before now, the only cryptocurrency known to the public was Bitcoin. But the popularity of bitcoin has, in turn, led to the introduction of many other coins and crypto exchanges. And unlike traditional centralized exchanges, these crypto exchanges have their price of tradable cryptocurrencies.
In simple words, the price of any given cryptocurrency differs across exchanges since the buyers and sellers do not correlate completely. But do you know you can take advantage of this? Let’s briefly discuss all it entails.
Cryptocurrency arbitrage trading
Cryptocurrency arbitrage trading means buying and selling coins to profit from the difference in prices across exchanges. This means that a trader can buy a cryptocurrency from a platform where the price is relatively low and sell to another platform at a slightly higher price. Now, the profit generated is equivalent to the difference between the two prices.
Cryptocurrency trading involves predicting prices, which requires top-notch analytical skills. However, with cryptocurrency 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 expected.
Note that there is no guarantee that you will always buy coins for a lower price and resell at a higher price. With the crypto markets getting more volatile, you may not get cryptocurrencies at your desired prices. But the principle to profit from an arbitrage trade is: buy low and sell high.
For example, let us consider two exchanges; Kraken and Coinbase.
Kraken – $31,420
Coinbase – $31,500
From the example above, the price of Bitcoin against the US Dollar is different at the same time. This is where arbitrage comes into action. To take advantage of arbitrage, BTC must be bought from Kraken and sold at Coinbase. Since you will be buying for a lower price and selling it for a higher price, the difference between the two prices will be your profit. Note that the profit does not include fees and other charges.
Choosing exchanges for cryptocurrency arbitrage trading
There are different crypto exchanges in the market. And as the options increase, selecting the right platform becomes challenging. But here are some factors to be considered while choosing exchanges to arbitrage.
We have different fees, including commission fee, trading fee, deposit and withdrawal fee, etc. All these fees could swallow your profit made from arbitrage. Hence, you should always compare the charges across exchanges and select those with lesser ones.
Geography and verification process.
Many cryptocurrencies are not yet widely accepted in various countries. And some exchanges do not operate in certain countries too. So check the availability of exchanges in your country. Traders should also understand the verification process before using the platform. Not all exchanges permit traders to buy and sell immediately after creating an account. In some platforms, the verification process takes days to weeks before successful completion.
Transaction and withdrawal time
This is a primary factor to consider in arbitrage. The lower the transaction and withdrawal time, the better the arbitraging opportunities.
The reputation of the exchange
Do not register with an exchange without understanding customer policies. Go through several reviews from legitimate portals and make sure that most reviews are positive before registering on the platform.
How Does Cryptocurrency Arbitrage work?
Here is a detailed step-by-step process to arbitrage using cryptocurrencies:
- Select the cryptocurrency you want to arbitrage. Verify its status, especially its availability on at least two exchanges, as you will need to have an account in the exchanges you want to use.
- Know the price of the cryptocurrency on both the exchanges and compare the volumes between them. You must also understand the rate at which the prices on the two platforms are changing.
- Quickly evaluate the difference between the prices.
- Identify the exchange offering the crypto for a relatively lower price and execute a “buy order.”
- Transfer the bought crypto to the second crypto exchange (where the price is relatively higher).
- Prompt a sell order on the second exchange.
- Repeat step 2 to step 6 until the difference in prices becomes insignificant.
Note that all the transactions, including buying, selling, and transferring, must take place spontaneously.
Pros of cryptocurrency arbitrage trading
- Since the cryptocurrency market is still in its development stage, liquidity is less compared to other developed markets like forex and equity.
- There are many options – different assets and exchanges.
- The volatility of cryptocurrencies gives traders the arbitrage opportunity, as they can observe massive price differences.
- Quick profits. Arbitrage trades are completed within minutes.
- The difference in fees significantly affects the profit margin.
- The number of exchange hacks is on the increase. So your coins become vulnerable to hacks by default since they are stored on an online platform.
Unlike trading, the nature of crypto arbitrage trading on the market seems simple because it does not involve studying charts and patterns to predict the market. It only requires basic mathematics and experience.
Cryptocurrency arbitrage is also less rewarding, but it is not as risky as margin trading and speculation. However, failure to master the art of timing can cause damages to one’s account.