What is arbitrage?
Arbitrage, in its simplest form, is the process of buying a stock on one market and selling it on another to take advantage of price listing differences across various markets.
For example, a car manufacturer is priced at $45 on the NYSE but is trading at $45.30 on the SSE. A trader purchases these shares on the NYSE and sells them on the SSE to make a 30-cent profit on each share. This is a basic example of arbitrage trading.
What is arbitrage trading in crypto?
Arbitrage crypto trading works in a similar way to conventional stock market arbitrage trading.
In the same way arbitrage traders seek to make gains by buying and selling across markets, crypto arbitrage traders look to profit from the varying list prices on different exchanges.
For example, an investor buys 100 Solana coins on the Coinbase crypto exchange at $14 per coin and sells them on the eToro exchange for $14.10 — meaning the investor made 10 cents profit per share by trading them on a new platform.
Types of crypto arbitrage
The only significant difference between crypto arbitrage trading and stock market arbitration is that there’s more than one way to do it.
Some of the common types of crypto arbitrage trading include:
Spatial arbitrage — Also known as geographical arbitrage, spatial arbitrage is when an investor simply buys cryptocurrency on one exchange, sells in another, and collects the profit. Investors can trade crypto between centralized exchanges (CEXs) or Decentralized exchanges (DEXs) and take advantage of an exchange’s technical inefficiencies — like pricing delays — and listing differences to profit.
Spatial arbitrage without transferring — The most common and simple form of arbitrage trading. An investor takes a long position on a cryptocurrency on one exchange and a short position with the same cryptocurrency on another exchange. This means investors can hedge against substantial losses and make small profits on price fluctuations across different exchanges.
Triangular arbitrage — The triangle aspect refers to three types of currency involved in a triangular transaction — the two coins and the fiat currency used. Triangular arbitrage works like this:
- The investor logs on to their crypto exchange or trading account and buys one Bitcoin on their account using their fiat currency — for example, pound sterling or US dollars.
- The investor transfers that Bitcoin to a different exchange or wallet and purchases 10 Ethereum using that Bitcoin.
- The investor then sells their current holding of Ethereum — for a higher price than the cost of the original Bitcoin — and buys back the original Bitcoin for the starting price to complete the triangle.
Although profitable when done correctly, these opportunities rarely arise, and this isn’t a method commonly used by traders.
How to find crypto arbitrage opportunities
It’s all well and good knowing how to put an arbitrage trading plan into action. However, prospective arbitrageurs must know how to spot these opportunities to act on them.
To spot a lucrative crypto arbitrage opportunity, investors must:
Browse the market for price changes — Whether manually or using a tracking tool to do the heavy lifting, comparing the prices of cryptocurrencies on a range of platforms is essential to know where to buy and sell. Specialist software can help investors scrape this data from various exchanges to highlight potential opportunities.
Use trading pairs — Trading helps gauge the comparative value of two cryptocurrencies or between a coin and a fiat currency. For example, an exchange might show that one Bitcoin token is worth X amount of Ethereum on the interface and vice versa. This value can be used to calculate how much a coin is worth when you trade, making it easier to identify if the exchange rate works in your favor.
Keep up-to-date with currency exchange rates — Another crucial aspect of arbitraging crypto is tracking the exchange rates of fiat currencies. For investors buying and selling cryptocurrencies across global CEXs and DEXs, understanding how the fiat currencies have moved can affect how much profit they’ll make when all the assets are sold.
Advantages of crypto arbitrage
Despite being an uncommon tactic, there are many potential advantages to arbitraging cryptocurrencies.
The main advantages of cryptocurrency arbitrage trading include:
Low risk — Because crypto arbitrage trading often involves buying and selling simultaneously or on different markets, traders hedge their losses with a counter investment, meaning there is minimal risk for the trade.
Potential for quick returns — Arbitrage trading has a quick turnaround — once investors spot an opportunity, they jump at it. The nature of rapid arbitrage trading and currency conversions at a desirable rate means that profits can be realized in a matter of minutes.
Industry Volatility — Volatility is usually not associated with positive financial investing, however, it’s a vital part of arbitrage. Cryptocurrencies are inherently volatile. Because the supply and demand of a coin are largely based on speculation, markets are constantly moving — exposing daily pricing errors and inefficiencies across many crypto exchanges daily. It’s these inefficiencies that open the door for traders to profit.
Works during bull and bear markets — Whether the market is rising or falling, the number of arbitrage opportunities remains the same. Although bull markets are more desirable, traders can hold both long and short positions and make money whether the markets bull or bear.
Disadvantages of crypto arbitrage
All investment strategies come with a level of risk – cryptocurrency arbitrage is no different.
Some of the drawbacks of crypto arbitrage include:
Withdrawal limits — Some cryptocurrencies limit the amount you can withdraw at any given time. Investors must understand these limits and select exchanges that offer the cheapest withdrawal fees to maximize profit on short-term trades.
Transaction Fees — All trading platforms and cryptocurrency exchanges won’t let you buy, deposit, or withdraw money or coins from a wallet without charging fees. Investors must factor these fees into account before taking arbitrage trades. Fees for buying, selling, and withdrawing coins or fiat currency can exceed the profit made by performing a successful arbitrage trade — adding extra layers of complexity for novice and experienced investors alike.
Slow Transaction Times — As competition for a share of the crypto pie ramps up, so do transaction times, due to the increased volume. Because funds need to be reallocated and withdrawn quickly, these slow wait times can be the difference between an investor profiting, missing out on an opportunity, or losing out entirely.
Precision Timing Needed — All trading is relatively time-sensitive, but none more than arbitrage trading. When prices across exchanges don’t match up, and an opportunity arises, investors have minutes or even seconds to react and turn a profit. Investors need to be quick to reduce the risk of the market turning against them, making it a method that’s most suitable for more experienced traders.
Frequently Asked Questions (FAQs)
Which coin is the best for arbitrage?
Arbitrage can be done with any crypto coin or token. However, coins with high volatility are most suitable as they open more opportunities for arbitration.
Cheaper tokens and meme coins – like Dogecoin, Shiba Inu, and Cardano – offer increased volatility and are also more accessible to investors with smaller portfolios.
Can you lose money doing crypto arbitrage?
Like any form of trading, if the market doesn’t fall in your favor — or you make a mistake on your inputs — you can lose money from crypto arbitrage.
Unfortunately, trading has real-world consequences, so it’s critical to be informed and practice on a paper money account before committing personal capital.
For more information on how to invest in crypto as a beginner and the potential pros and cons of trading, check out our helpful guide!
Is crypto arbitrage legal?
Crypto arbitrage trading is not only legal in the majority of countries across the world, but it’s also encouraged.
It helps iron out market inefficiencies by making it easier for centralized and decentralized markets to receive a steady supply of coins to fulfill demand without affecting the market price.
How to learn crypto arbitrage?
When learning any form of trading, it’s important to learn from the best and practice the strategy in a safe environment.
Most exchanges offer investors the option to set up a paper account. A paper account lets novice investors set up and try different investment strategies — including crypto arbitrage trading – without the risks associated with committing capital straight away.