What Is Crypto Arbitrage Trading & How Does It Work?

Crypto arbitrage trading allows traders to take advantage of the differences in prices across from one exchange to another. Since crypto exchanges value cryptocurrencies differently, that opened up opportunities for arbitrageurs to profit from the crypto price differences by buying an asset at a lower price and immediately selling it on another exchange.

A worthy note is crypto arbitrage trading is highly dependant on the speed and the volume of each trade. So, to master this trading style, there will be no shortcut, and it needs to be executed precisely.

Key Takeaways

• Understand what crypto arbitrage trading is and the concept inside and out.

• Get an in-depth evaluation whether crypto arbitrage trading matches your expectations.

• Learn how to calculate the profit and losses from crypto arbitrage trading.

• Critically identify the risks of this trading strategy and how to mitigate the risks.

Here, we’ll discuss the process in crypto arbitrage trading, the benefits, and the risks this trading style associates. To add on, we’ll be shedding some light on the key peculiarities of this approach. Particularly to discern the essential bits of advice for those who want to try their luck in the volatile crypto market.

What Is Cryptocurrency Arbitrage?

Crypto arbitrage trading is the profit-making strategy by exploiting the difference in assets’ prices in different markets. Mainly through the purchases of digital currency on one exchange for a lower price and quickly selling it on another one at a higher rate. 

For example, if Bitcoin (BTC) price is higher on X exchange than Bybit, you can buy BTC on Bybit and sell it on X exchange and profit the price difference.

These crypto arbitrage traders (arbitrageur) usually pry on the price difference of the same asset but in different exchanges. In the end, to trade them as quickly as possible to earn the differences. While the most common factor that causes these price differences could be the trading volume that causes a shift in the supply and demand levels.

That said, crypto arbitrage trading are generally less risky but the returns are generally lower too. Still, the tricky part about trading crypto is to fully understand how it works and to apply it strategically for maximum returns. So, let’s dive right into it.

How Does Arbitrage Trading Work in the Crypto Market?

With the growth of Bitcoin’s popularity, the number of cryptocurrency exchanges grows. However, this market is far from being homogeneous. And the BTC and ETH price may differ significantly on various exchange platforms at a given moment which results in various opportunities for arbitrage trading.

Let’s say, in a given moment, Jay realized 1 BTC costs $50,000 on Bybit and $50,200 on exchange X. If Jay is lucky enough to spot this difference and have the financial capabilities to quickly buy the BTC on the first platform and sell at the other one, he’ll earn the difference that makes up for $200 in profit.

In any case, if Jay is adventurous to do a cross-border triangular arbitrage across three exchanges offering different pricing for BTC, he can make quick small profits within a short period.

Definition:

Triangular arbitrage is a trading strategy exploiting the opportunities to exchange three foreign currencies across the exchanges then exchanging it back to the original currency in a short amount of time.

How Does The Crypto Price Work?

The question you should be asking is, where do these differences come from, and how is a cryptocurrency’s price shaped? 

The adherents of traditional finance claim that Bitcoin is not backed up by anything. At the same time, their opponents genuinely believe in its value as it provides a possibility to exchange funds on a peer-to-peer basis. Generally, any given cryptocurrency has value as long as people are willing to buy and sell it. 

Crypto exchanges provide both parts of a deal with a convenient place to set up the order while the demand and the offer do the rest to regulate cryptocurrencies’ prices. In any case that the crypto trading volume surge in a larger exchange, the price tends to be lower per asset because the same dollar investment translates into more assets.

Take Bitcoin for an example, the average time to confirm a transaction is around 10 minutes. So if the BTC market price dips within the set time frame, you may risk a lower return from arbitrage. While crypto arbitrage is possible, the volatility means the price fluctuation is tremendous and to execute an ideal arbitrage is time-consuming and requires patience.

What Are The Crypto Arbitrage Trading Methods? 

There are four main methods derives from the concept of arbitrage trading when it comes to the arbitrage execution stage. Here’s are some of the essential trading methods:

Simple Arbitrage

This strategy works precisely as the name suggests. A trader can simply buy an asset on one exchange and sells it on another one at higher rates getting well-earned profits. There aren’t any restrictions as to how many positions or transactions a trader can perform. Ultimately, the goal is to earn quick profits through multiple transactions simultaneously.

Triangular Arbitrage

This type of trading requires adding one more component into the equation. Triangular arbitrage allows you to gain profits through the price discrepancy of three different assets on an exchange or across multiples exchanges.

As many exchanges provide a wide variety of trading pairs, they convert funds like USD into BTC and ETH, XRP, and others. This gives traders the upper hand to test the market for an excellent price of more than only two cryptocurrencies.

Statistical Arbitrage

This method is the most complicated of all as it requires market statistics analysis on hand and opens multiple orders simultaneously. The main idea of statistical arbitrage is that you rely on historical data that never repeats itself with 100% precision.

Automated Arbitrage 

Human eyes are imperfect, and neither is the speed of their reaction. The currency prices change within a blink of an eye, and even if you are lucky enough to spot a trading opportunity, there is no guarantee that you will be able to act fast enough to make profits. That’s when automated trading comes in handy.

Different companies develop various bots that help traders make profits via arbitrage trading in an automated way. That’s when human errors, repetitive tasks, timing inaccuracy can be mitigated effectively. And among the wide selection of crypto bots, 3Commas, Napbots, and HaasOnline are among the best.

DeFi Arbitrage

Decentralized finance (DeFi) eradicates the use of intermediaries to function as a financial protocol. DeFi boasts the use of stablecoins and smart contracts for value transferring digital assets to lending and yield farming. Since DeFi heavily relies on coded architecture, it also opened up opportunities for DeFi arbitrage.

For example, if platform X offers 10% yields from a stablecoin but platform Y offers 12% yields, a trader can shift his funds from A to B to earn 2% higher yields.

In any other cases, a trader could also choose to deploy another strategy to spatial arbitrage across different exchanges. Except it mainly involves decentralized exchanges (DEX) like Uniswap rather than a centralized exchange (CEX). With the same concept applies, a trader would trade the digital asset across the DEXs to gain profit off the discrepancy. However, do take note that DeFi arbitrage takes gas fees into consideration. Plus, since gas fees are not immutable, thus, your profit margin from DeFi arbitrage will be varied from time to time.

Is Crypto Arbitrage Profitable?

Suppose you are a newbie in the world of crypto trading. Realistically, the chances for you to actually gain profits are rare. But, it’s not possible if you have the right set of tools and knowledge for spatial arbitrage.

For example, 1 BTC worth $54,000 on exchange X, and 1 BTC is listed for $54,010 on exchange. In that case, you can focus on spatial arbitrage to earn profits from these spreads daily. Though, the profits are highly dependent on the spread size and how quickly for you to take action on these opportunities. Ultimately, the larger the spread, the higher your profit gains with arbitrage trading. A good note here is to take trading fees into account when arbitrating. Suppose your earning margin is around 2% of an asset, but the trading fee is 0.5%, that means your net profit is down to 1.5% or lesser depending on the calculation for different crypto exchanges.

Of course, crypto arbitrage trading works. But with trades that are executed almost instantaneously, so to actually profit from this trading technique is rather difficult these days. Not to mention the advanced technologies that are working with little to no downtime to eliminate price errors. An alternative to manual arbitrage trading would be using a trading bot to buy and sell cryptocurrencies automatically across multiple exchanges. But the challenging part would be to customize to fit your trading requirements.

How to Calculate the Profit and Loss of Crypto Arbitrage?

The eventual sum that you win or lose while performing arbitrage trading on cryptocurrency exchanges is not merely the difference between a given asset’s prices. In addition to your gains or losses, there is a wide variety of factors that you should consider when calculating your final profits or losses.

For one, there are different transaction fees you may encounter while performing a trade. These include the:

• Maker and taker fees that you pay on both platforms where you buy and sell a selected asset. The size of these fees usually varies from 0.02% to 0.1% and is generally mentioned on the platform’s website. For example, at Bybit, these numbers make up -0.025% maker fees and 0.075% taker fees correspondingly.

• Deposit fees on the exchange are where you will buy the asset (if there are any). With Bybit, the deposit is always free.

• Withdrawal fees on the exchange are where you will sell an asset. Typically, these vary depending on the asset that you are withdrawing.

• Final withdrawal fees after the transaction are complete.

As great as these fees are used to sustain the crypto exchanges, it’s undeniably a cut of the profits you’re making. Here are some workarounds that can help you reduce them:

• Make thorough research and select and exchange the charges lower fees when compared to the others. 

• Some platforms do not charge withdrawal fees when you take away your money in crypto instead of fiat. Though, that is rare.

• If you’re lucky to spot a perfect match between two cryptocurrencies, your order can be conducted immediately without any time lab and fees.

• If you upload the funds from a credit card, the fees will be higher as compared to wire transfers. 

Things to Take Note for the Calculation

In addition to the fees, many other factors can have a sustainable effect on the final profit. These factors include:

• Market volatility. At some moments in time, some cryptocurrencies have such a high level of volatility that their price may change within seconds while you accomplish a transaction.

• Taxes. In some regions, cryptocurrencies have been acknowledged by the local jurisdiction and are subject to taxation. Thus, in the U.S. and Australia, Bitcoin is regarded as property or investment and is subject to capital gain taxes. However, Germany is considered private money with a progressive income tax up to 45% if it is owned for less than a year.

The final sum that you spend on fees may range anywhere between 3% and 15% of your total capital. That’s why you should think twice before entering this trade or the other.

Is Crypto Arbitrage Trading Legal?

Yes, cryptocurrency arbitrage is legal traders mostly benefit from the discrepancy of cryptocurrency markets. As we know each crypto exchange is unique from one another. That means rules set by one exchange could be a favor to another. Ultimately, it’s all based on how you can put things into perspective and make the most out of them. However, unfortunately, a few countries still put an official veto on Bitcoin and all other cryptocurrencies, such as India, Bolivia, Egypt, Ecuador, and others. This means crypto arbitrage in these regions may or may not be legal depending on the local rules. It’s always best to check with the local authorities before diving into crypto in general.

Still, the crypto market is yet to mature and many crypto assets remain volatile as compared to traditional stocks and bonds. That’s what contributes to the whole enterprise and provides more substantial opportunities for crypto arbitrage.

Crypto arbitrage opportunities emerge as a result of market inefficiency rather than individual actions. Naturally, the more traders involved in crypto arbitrage, the more stabilized the market and higher trade volume for exchanges. As a result, lesser arbitrage opportunities for other traders to benefit from the discrepancy.

What Are The Risks of Crypto Arbitrage Trading?

If you have ever been engaged with crypto trading, you must know that this crypto trading is pretty risky due to its high volatility. Yes, specific patterns signify for an asset’s price to go up or down, but the outcomes are never guaranteed.

Crypto arbitrage opportunities are associated with a different set of risks that affect the final profitability. For one, these are the trading fees that we have already discussed above. Suppose the difference between the asset price is not high enough. In that case, your losses may eventually get higher than your profits due to all the fees that you will have to pay before you ultimately get the funds to your wallet.

The Know-You-Customer (KYC) procedures implemented on exchanges can make it harder for a trader to conduct cross-border transactions. To exchange a substantial amount of funds on a single platform, you will have to provide them with your IDs. Typically, centralized exchanges invest a significant amount of time and effort into security. However, sometimes the data leakage can still occur, and your data leak into the hands of fraudsters.

Pros of Crypto Arbitrage

Due to its complexity, crypto arbitrage is undoubtedly not for newbies. However, seasoned traders can benefit from the following aspects:

• Quick profits. You can conduct a transaction and gain your earnings as soon as you spot an opportunity. Unlike mid and long-term investments, where you have to hold a specific asset for a certain period, you gain profits practically immediately with crypto arbitrage. 

• The infancy of the crypto market. The cryptocurrency market is still in its early stages of development, which means that crypto arbitrage opportunities will be available for a long while until the market settles down.

• High volatility. As Bitcoin is a decentralized cryptocurrency, it is not regulated by any central authority, which leads to a pretty high level of volatility compared to traditional stocks and bonds. That leads to more significant changes across different platforms and more opportunities for crypto arbitrage. 

Cons of Crypto Arbitrage

In addition to the risks that we have already discussed above, crypto arbitrage has a few other downsides that are worth considering before you decide to test your luck in this business:

• Security. There is no central bank in the world of cryptocurrencies to be accountable for lost funds or to reverse a transaction. To perform crypto arbitrage, you must store your assets on multiple exchanges. However, there are few exceptions, like Bybit, who’ll reimburse the losses in case of system errors.

• Fees. The number of fees that you will have to pay during the whole process may turn out to be a significant sum. Hence, significantly deducting the profits.

• Withdrawal limits. Keep in mind that some exchanges have their limits on the sum that you can withdraw from the platform in a single day. Thus, it may take a few days to get them to your wallet or bank account when you trade large amounts.

• Fast reaction. Typically, crypto arbitrage opportunities last for a pretty short period, and you have to be pretty fast to make any gains. It usually takes up to several minutes to conduct a deal, but even within that short timeframe, the market may move significantly, and your fast reaction will be of no help as you will lose the money.

• Competition. As the market matures and more traders seek to make their gains in crypto arbitrage, the competition grows higher while the number of opportunities decreases. 

Who Is Suitable for Crypto Arbitrage trading?

Crypto Arbitrage is a better fit for seasoned cryptocurrency traders who already know how the market works and have managed to develop their trading strategies. 

How to Crypto Arbitrage Trading?

If you have decided to test your luck in crypto arbitrage, here are some step-by-step guides on how you can do this, depending on the strategy you select. 

Arbitrage on Different Exchanges

This method requires creating accounts on several exchanges and passing verification on them. Getting profits is more complicated as you will have to transfer funds between different exchanges, which in some cases may take up to several days. However, there is a workaround for this:

1. Create accounts on two different exchanges and pass verification there. 

2. Deposit fiat to both of these platforms.

3. Exchange half of the deposited sum to Bitcoin or any other cryptocurrency.

4. When an arbitrage opportunity appears, buy cryptocurrency quickly on the first platform. Then switch the same amount of cryptocurrency back to fiat on the second platform. 

Thus, you will not have to transfer funds between two different platforms, which will help you save your money on withdrawal fees.

Arbitrage on a Single Exchange

Performing crypto arbitrage on a single platform is a lot easier. But don’t forget that there are other traders and the competition may be higher in this case. 

1. Register on the platform and pass verification to be able to deposit fiat money. Ensure that the platform allows trading cryptocurrencies against Bitcoin but against some other altcoins such as Ether or USDT.

2. Deposit funds from your bank account or a credit card and start looking out for arbitrage opportunities.

3. Whenever there’s an opportunity, buy and sell crypto strategically, then finally convert it back into fiat. Note that sometimes more than two cryptocurrencies can be involved in the process.

How to Select an Exchange for Crypto Arbitrage?

Before you start trading, you should do proper research and find one or several trading platforms that will fit you best. Mind the following aspects when you investigate different options:

• Security. Check if the platform’s website has an SSL certificate. If it offers multi-factor authentication or a cold wallet system to secure user’s funds.  

• Geographical limitation. You can hardly find a cryptocurrency trading platform that will be supporting users all across the globe. Check if your country is on the list of restricted regions.

• Reputation. Actively search for reliable reviews on the platform. Try to focus on constructive feedback.

• Verification. Find out which documents you have to upload for validation. Most platforms require their users to upload personal data to provide them with the possibility to upload and withdraw funds.

• Liquidity. Check the daily trading volume on the cryptocurrencies you select. Sometimes platforms are unable to provide sufficient liquidity, which may be a big problem if you are going to exchange huge sums.

Tips to Mitigate Crypto Arbitrage Trading Risks

There are a few essential things that you should know before you try crypto arbitrage trading. Here are some useful tips that you should keep in mind.

Tip #1. Avoid Arbitrage Trading Bitcoin

Although Bitcoin is the most popular cryptocurrency so far and provides more arbitrage opportunities than other altcoins, it may not be that profitable. The Bitcoin network has a minimal throughput as it allows transferring only seven transactions per second. 

The more people try to convert Bitcoin in a given moment, the longer they will have to wait, and the higher the transaction fees will be. That may significantly reduce the potential profits with crypto arbitrage.

Instead of Bitcoin, try looking out for opportunities associated with all the cryptocurrencies with lower competition and higher throughput indices. For example, Bybit offers such trading pairs as EOS/ETH, ETH/USD, and a few more.

Tip #2. Look Out For New Listings

When a new cryptocurrency is listed on a given exchange, there are good chances that this coin’s demand will be relatively small, at least in the beginning. This opens broad horizons for crypto arbitrage opportunities and can help you multiply your wealth significantly. 

Tip #3. Diversifications

Get yourself a verified account on as many exchanges as you can. The broader is the selection of your platforms, the more arbitrage opportunities you may spot. A diversified portfolio is always ideal for balancing out the profits and losses.

Tip #4. Develop Your Strategy 

Like cryptocurrency day trading or swing trading, you must develop your strategy when you go to arbitrage. Before you start trading, evaluate your capital, adjust your profit expectations, and formulate a contingency plan if things go sideways. Answering all these questions will help you get the situation under control instead of merely relying on your luck. 

Tip #5. Automate your strategy with bots

In the crypto market, many companies develop bots to help traders automate their activities. Of course, there are both available for crypto arbitrage as well. 

Bots are the programs that execute transactions when the predetermined conditions are met. Unlike humans, they can sport arbitrage opportunities in a much more efficient way and make many routine activities on themselves. 

Summing Up

Crypto arbitrage is just another way of making money in this precarious industry. When treated with due diligence, it might become a good source of income for an experienced trader and also help you diversify your portfolio.