Cryptocurrency trading involves a range of strategies. The most popular are those employed by day traders in the crypto market. However, there are other approaches that do not demand the same level of expertise as day trading.
Cryptocurrency arbitrage trading is a strategy that doesn’t require advanced trading skills, but it is not exactly “easy.” It still necessitates a certain understanding of the crypto markets. How does it work?
What Is Crypto Arbitrage Trading?
If you’ve checked multiple exchanges at the same time, you may have observed that the price of Bitcoin varies among them. One exchange may have a higher or lower price compared to the others.
This phenomenon is not unique to just one market, it’s present in stocks, commodities, metals, and in the crypto market as well, leading to the rise of cryptocurrency arbitrage trading.
Cryptocurrency arbitrage trading is a strategy in which one buys and sells crypto assets, taking advantage of price disparities between different exchanges to earn a profit.
Arbitrage is a strategy that anyone who can purchase and sell crypto assets on exchanges can employ to earn a profit. It is often considered a low-risk trading method that doesn’t require significant trading expertise.
How Does Crypto Arbitrage Trading Work?
Arbitrage trading involves purchasing crypto assets on one exchange and then selling them on another, taking advantage of price differences. Essentially, you buy Bitcoin on exchange A where it is cheaper and then sell it on exchange B, where it is slightly higher priced.
To gain a clearer understanding, go to CoinMarketCap and select Bitcoin to observe the price differences across various exchanges.
As of writing, the price of Bitcoin on Binance is $20,141 and on Huobi Global it’s $20,130. Hence, if you purchase from Huobi Global and sell on Binance, you can earn approximately $11 per Bitcoin.
It’s important to note that since the cryptocurrency market is extremely volatile, trades must be executed rapidly, almost instantaneously, to avoid price changes. This may not pose an issue in certain forms of arbitrage trading, as we will discover in the near future.
However, the volatility also creates more opportunities for arbitrage trading in the crypto market than in other markets.
4 Types of Crypto Arbitrage Trading
There are various forms of crypto arbitrage, which vary based on the methodology and participants involved. Here are the four primary forms of crypto arbitrage.
1. Inter-Exchange Arbitrage
This type of crypto arbitrage trading involves buying an asset from one exchange and selling it on another, utilizing only two exchanges.
Since the real-time prices of assets determine this type of arbitrage trading, it is not feasible to purchase assets on one exchange and then transfer them to another exchange for sale.
This challenge can be overcome by conducting the purchase and sale of the asset simultaneously, provided that the assets are held on both exchanges. This eliminates the need for transferring the assets and reduces transaction fees.
Let’s assume you possess $20,000 worth of USDT on Binance and 1 BTC on Kraken.
With Bitcoin valued at $20,300 on Kraken and $20,000 on Binance, you can profit from this discrepancy by buying Bitcoin on Binance using $20,000 worth of USDT, and concurrently selling it on Kraken for $20,300.
By avoiding the need to transfer the Bitcoin from one exchange to another, you can save on withdrawal and deposit fees, allowing the $300 price spread to become your profit.
2. Triangular Arbitrage
This form of arbitrage requires the use of three different assets, but it’s more straightforward as it only involves one exchange.
Assuming you own Bitcoin, Solana, and Ethereum, if Solana and Ethereum are priced lower on the exchange, you can take advantage of this opportunity by converting them to Bitcoin, effectively increasing your Bitcoin holdings.
For instance, you can trade your Bitcoin for Solana, then Solana for Ethereum, and finally Ethereum back to Bitcoin.
End with more Bitcoin after converting it to Solana and then to Ethereum, without incurring high gas fees for sending Ethereum to another exchange.
No fees for withdrawal, transfer, or deposit are incurred as it is all done on the same exchange.
3. Statistical Arbitrage
Statistical arbitrage involves using math models to trade assets and make a profit from price differences. Automated arbitrage bots are used, allowing for simultaneous trading of multiple assets.
Bots in statistical arbitrage use mathematical models to determine whether a trade will be profitable and execute trades accordingly.
This type of arbitrage involves the use of automated bots and mathematical models to trade assets, reducing human involvement and the risk of error.
4. Spatial Arbitrage
This form of arbitrage exploits price variations of an asset caused by geographical differences between exchanges. It is similar to inter-exchange arbitrage, except it focuses on geographical differences.
Spatial arbitrage profits from price differences between assets in different geographical locations. Similar to inter-exchange arbitrage, it exploits demand differences in different countries. E.g., purchase Bitcoin from a foreign exchange with lower demand and sell on a local exchange in a high-demand country.
Spatial arbitrage takes advantage of differences in the asset price due to differences in location of each exchange. Similar to inter-exchange arbitrage, it leverages differences in demand for the asset. E.g. if you’re in a country with high demand for Bitcoin, you can buy it from an exchange with lower demand and sell on a local exchange, making a profit due to the higher demand. Unlike inter-exchange, you don’t have to buy and sell in real-time and can manually transfer the asset.
Pros and Cons of Crypto Arbitrage Trading
Crypto arbitrage trading has both advantages and disadvantages.
- Low-risk trading strategy that requires little experience
- Can be done during both low and high volatility
- Not many fees are involved in most arbitrage trades
- Volatility causes rapid changes in price, which may be a challenge in inter-exchange arbitrage
- May require assets on at least two exchanges
Is Crypto Arbitrage Trading Right For You?
Crypto arbitrage trading offers the potential for profits, with lower risk compared to day trading, where the trader takes on the market’s movements.
Crypto arbitrage trading is a good option if you meet the requirements and conditions. It can yield high profits and carries low risk compared to other trading methods.
The information on this website does not constitute financial advice, investment advice, or trading advice, and should not be considered as such. MakeUseOf does not advise on any trading or investing matters and does not advise that any particular cryptocurrency should be bought or sold. Always conduct your own due diligence and consult a licensed financial adviser for investment advice.