What is cryptocurrency arbitrage?

Arbitrage can be defined as buying of one asset on a different market and selling it in another market for a higher price. In cryptocurrency arbitrage, you can search and compare the price of coins in different exchanges. You then buy from the cheaper exchange and sell in the exchange where the price is higher. You will then have the price difference as your profit.

Arbitrage has been in existence in foreign exchange markets for long but has been out of reach due to massive developments in quantitative systems. Cryptocurrency arbitrage is, however, possibly due to the rapid surges in trading volumes and inefficiencies in exchanges which cause differences in price.

In most chances, big exchanges that have high trading traffic direct the price of coins in smaller exchanges with fewer trade volumes. However, there are always changes that the prices are different on the exchanges. This is where cryptocurrency arbitrage is possible.

How cryptocurrency arbitrage is performed

For starters in cryptocurrency arbitrage, the most common and easy way to approach it is through manual monitoring. Take a look at the prices of your preferred cryptocurrencies, monitor their prices on different exchanges, place your trades then transfer the funds accordingly.

There are also cryptocurrency arbitrage bots that have been created to monitor the prices movements and differences of coins in the market. Additionally, mobile trading apps can also help in the monitoring process to help you keep note of any changes that can help you make a profit.

Types of cryptocurrency arbitrage

1. Pricing

The prices of coins are different on different exchanges. Coinlib has a service specifically designed for arbitrage called best price explorer. Here, there is a list of all exchanges for a specific market with a rank from the most expensive to the least expensive. Through best price explorer, you can decide if you will explore cryptocurrency arbitrage depending on your chances for profit.

In order to explore price arbitrage, you should consider

• Fees for trading a coin
• Fees for depositing or withdrawing a coin
• Blockchain network fees
• Time taken to move a coin from one exchange to another

If all these options show that you can earn a profit with arbitrage, then you can go ahead and make the trade. Remember that arbitrage highly depends on time hence it is not a permanent opportunity to make a profit. If a lot of time is required for your trade to be confirmed, the price might change affecting the risk.

1. Geography

The supply and demand of cryptocurrencies in a certain country might make their prices different from the rest of the world. For instance, last year saw the price of Bitcoin in Zimbabwe skyrocket as the supply and demand did not match. A lot of people preferred transacting in BTC due to the volatile nature of their local currency. Also, their wanted to store their money in Bitcoins as their currency was experiencing inflation.

This could be a huge chance for cryptocurrency arbitrage. Buying from an exchange in a different country and selling to people in countries where the price is very high can help you make a profit. You should, however, be cautious of any legal regulations against cryptocurrencies as well as withdrawal limitations that can affect your trade.

• Listing

The demand for coins usually goes up once they get listed on exchanges. Moreso, when they get listed on large exchanges, they pose a high chance for cryptocurrency arbitrage that you can explore. For example, when a coin gets listed on an exchange like Binance, it experiences a growth in value and a lot of people want to buy it. Buying from other smaller exchanges and selling on Binance at the higher price is an example of cryptocurrency arbitrage.

Strategies

As a cryptocurrency arbitrage trader, there are different strategies you can use to make a profit. These include;

• Convergence arbitrage

This strategy is similar to using pricing arbitrage. As a trader, you take advantage of differences in prices on exchanges by buying where a coin is undervalued and short-selling it in an exchange where it is overvalued. You make a profit from the amount of convergence when the two separate prices meet in the middle.

• Simple arbitrage

This strategy involves just one coin. This is where you buy a coin and sell it immediately on a different exchange to make a profit.

• Triangular arbitrage

You use this strategy by taking advantage of the price difference of a coin between three currencies. The price of BTC in USD can be different to EUR and YEN. So you can buy BTC in USD, and then sell the BTC to make EUR. You then exchange the EUR you have made back to USD. It is not as complicated as I have made it look. The three currencies are BTC, USD, and EUR.

Reasons for cryptocurrency arbitrage

Cryptocurrency arbitrage has been explained in a previous post.  As a trader, there are several reasons as to why you can consider cryptocurrency arbitrage.

1. Many exchanges

There are over 200 exchanges in existence in the market. You can compare prices of coins and tokens on a wide range of exchanges to help you choose coins to trade with and exchanges to trade on. The many exchanges increase the chances for you to exercise pricing arbitrage.

2. Volatility of cryptocurrencies

A look at the market performance of a coin in the last week alone will show you how volatile the cryptos are. The volatility in the market can help you make a profit with low risks for cryptocurrency arbitrage. This will, however, need you to be very keen and ensure your predictions are well thought. By studying the market, you can use other strategies to ensure the market is not against your trades.

3. Fast way to turn a profit

Cryptocurrency arbitrage deals can take place in a few minutes. This is also advised because taking too long to make the trade might lead to losses when the prices in the exchanges change. Therefore, cryptocurrency arbitrage will potentially bring you more profit than other traditional approaches of buying and holding coins to sell at a later date.

4. The infancy of cryptocurrencies

The fact that cryptocurrencies are in their infancy stage means that there is little regulation in trading. There is also a disjoint between the coins and information transfer between exchanges, platforms and industry players is slow. The numbers of traders are also fewer as compared to FoRex trading. These factors increase the opportunities that can be available in cryptocurrency arbitrage.

Risks in cryptocurrency arbitrage

In theory, cryptocurrency arbitrage seems simple and risk-free. But if it was that simple, why is everybody doing it? There are risks and barriers involved that anyone interested needs to know and be wary of. With this knowledge, then you can join and possibly benefit.

• Exchange Fees

Most exchanges charge fees on any trades, miner fees, deposits, and withdrawals. you to make a profit, you need to factor in the effects that these fees will have on your trade. The profitability will be determined by the amount of fees that you are required to pay. Always remember that fees will minimize, if not eliminate the profit you expect from cryptocurrency arbitrage

• KYC regulations

Know your customer regulations can pose potential risks to joining exchanges. Sometimes you are required to hold a bank account in the country where an exchange is based for you to place a trade.

• Withdrawal limits

Exchanges often have a limit on an amount one can withdraw from their wallet in a day. If you want to place large trades, it might be hard for you to make profitable arbitrage deals. Make sure you know the limits to the funds you can withdraw before starting cryptocurrency arbitrage on any exchange.

• Slow transactions

Trading volumes in the global crypto market have increased. This can potentially affect the transaction speeds in exchanges. There have been records of delayed withdrawals which can affect someone seeking to profit from arbitrage. Additionally, you should consider the transfer time for all the coins you are trading with since they are different. BTC transfers are slower than ETH transfers. The miner fees are also a consideration when a transaction is started. If you choose lower fees for transfer of funds, then your transaction time will be affected, possibly affecting your returns.

• API call rates

There are API call rate limits in many exchanges. This means that as a trader, you can query data at the exchange X times in Y seconds. These limits are different on all exchanges and they limit the actions you can take. You are advised to be attentive on the number of times you send a request because you may exhaust your chances early. There are interfaces that can help you manipulate this but they are very rare. These are WebSocket APIs and FIX sockets.

• API integration

The market does not have a unified or standard definition of what an exchange’s API can do or the data it should have. You are therefore left to study each exchange, understand how they work, know their rates, authentication and how they handle their data types. This is time-consuming and may often be confusing, affecting your cryptocurrency arbitrage profits.

• Failing to execute in time

A risk you should understand in cryptocurrency arbitrage is that the market may shift against you in a matter of seconds. Also, if you delay before executing a sell trade, another trade might take place. Time taken to move coins from one exchange to another can see a rapid change in price.

• Storing coins on exchanges

In order to participate in cryptocurrency arbitrage, your coins will need to be stored in an exchange so you can use them when needed. This is a risk in security as there have been many cases of exchanges being hacked and crypto stolen.

• Large trades

Trading in cryptocurrency arbitrage seems like a very profitable course. However, taking into consideration the fees and delays, profits might be very small. You may, therefore, need to carry out large trades for you to realize large returns.

• Risk of competition

More traders are joining the crypto space. Also, more of the traders are learning and experimenting with cryptocurrency arbitrage. There may be an increase in competition in the future.

This article first published on coinweez.