What is Cryptocurrency Arbitrage: Basic Principles, Methods, Benefits, and Risks

There are a large number of solutions for earning money on the cryptocurrency market. Beginners take a simple and clear path to making a profit, experienced traders combine options for increasing capital using many available methods.

Cryptocurrency arbitrage is one of the promising and popular sources of profit among cryptocurrency world players. From the materials presented in the article, you will learn what cryptocurrency arbitrage is, what its advantages are, what risks it has, as well as everything about the types of crypto arbitrage.

What is Cryptocurrency Arbitrage

Arbitrage is the process of making profit from the difference in the prices of the same asset.

As in stock markets, this approach works in a similar way with cryptocurrency. Speaking about the concept of cryptocurrency arbitrage, it can be defined as the process of earning on the difference that is set for the price of one asset in different trading pairs or on different exchanges, P2P platforms and other trading platforms.

A trading pair is a pair of assets that are involved in a buy-sell transaction on a certain exchange, for example, Bitcoin/US dollar. However, the price of one trading pair may differ on different exchanges. For example, on one exchange, it is possible to buy BTC for $61,000. On another exchange, the BTC/USD currency pair will be traded at a price of $61,500 per Bitcoin. The trader buys Bitcoin on the exchange where its rate is lower and sells it on the platform where the price is higher. Thus, with the help of crypto arbitrage, the trader makes a profit of $500.

There are also a number of ways to earn money using more complex schemes, in which cryptocurrency is converted in several stages.

Basic Principles of Cryptocurrency Arbitrage

When talking about what cryptocurrency arbitrage is, it is worth paying attention to the principles on which it is based. For cryptocurrency arbitrage, the following are important:

• price differences: the essence of arbitrage is to detect moments when the cryptocurrency rate differs significantly on different exchanges or in different trading pairs;
• Speed: Arbitrage requires speed, as cryptocurrency price differences can be short-lived. To speed up the process, many traders use various automated tools to track cryptocurrency prices;
• Liquidity: for successful arbitrage, the selected exchanges must have sufficient trading volume to sell and buy the required amount of cryptocurrency;
• low commissions: the lower the commission prices on the exchanges, the higher the potential profit from arbitrage;
• risk accounting: to make a profit from arbitrage, you need to take into account the risks, which we will discuss later in the article.

Examples of successful arbitrage deals

Of course, arbitrage can make impressive profits. However, the deals that bring a trader colossal income are either kept secret or, even if discussed in blogs or forums, do not guarantee reliable information: the results may be exaggerated for advertising purposes, the data may be presented as schemes, but not contain specifics.

In any case, experienced users have identified trends over the years of productive trading that may indicate a potentially successful trade, namely:

• Flash crash: let’s say the price of an asset has fallen sharply on one exchange, while on others it has remained the same. The trader buys at a lower price and sells where the asset is significantly more expensive;
• release of a new cryptocurrency: in the first hours after listing, the price may differ significantly on different exchanges;
• news: The emergence of important news related to cryptocurrency can cause a short-term deviation in price, which will be a great opportunity for arbitrage.

Types of Cryptocurrency Arbitrage

Cryptocurrency arbitrage involves a large number of different schemes. Let’s consider what they are.

Simple, or inter-exchange arbitrage of cryptocurrency

Simple (inter-exchange) cryptocurrency arbitrage is the purchase and sale of an asset on different exchanges. A trader buys cryptocurrency on the exchange where it is cheaper and sells it on the platform offering a higher price.

If, for example, Ethereum is priced at $3,500 on one exchange and $3,400 on another, a trader will buy digital money on the second exchange and sell it on the first, since the offered price of $3,500 is higher.

The possibility of simple cryptocurrency arbitrage appears due to such factors as:

• different liquidity: large exchanges have higher trading volumes and, therefore, more stable prices;
• exchange desynchronization: asset price data is not updated simultaneously on exchanges, which creates time windows for inter-exchange arbitrage;
• technical glitches: sometimes technical errors on one of the exchanges can cause a temporary price deviation.

Simple arbitrage can generate significant income, although the cost element associated with commissions may be higher when compared to the figures for in-exchange arbitrage.

Intra-exchange cryptocurrency arbitrage

This type of arbitrage involves conducting transactions within one exchange. In this type of arbitrage, the trader uses the temporary difference in prices of the same cryptocurrency on different trading pairs within one exchange. In simple terms, the trader buys cryptocurrency at a lower price within one trading pair in order to sell it through another trading pair – the one that offers higher prices for the asset of interest.

For example, there are two trading pairs on the exchange: BTC/USDT and BTC/BUSD. Due to various factors such as trading volume, supply and demand, the Bitcoin rate may differ slightly between these pairs. If BTC/USDT is cheaper than BTC/BUSD, a trader will buy BTC for USDT and then sell it for BUSD, making a small profit on this price difference.

With intra-exchange arbitrage, a trader does not have to spend time to conduct transactions between several exchanges, and he is also offered relatively low commissions.

The key disadvantage of intra-exchange cryptocurrency arbitrage is the prompt reaction of the exchanges themselves. Exchanges constantly analyze the rate and, if correlations are detected, eliminate the difference in price, which sometimes gives zero income, therefore, the transaction does not increase the trader’s capital.

Triangular arbitrage

A more complex combination of intra-exchange arbitrage. In this arbitrage, three currency pairs are used, and the transaction looks like this:

1. There is a starting currency, for example, USDT .
2. First operation : Buying BTC for USDT.
3. Second operation : Selling BTC for ETH.
4. Third operation : Sell ETH for USDT.

Multicurrency Inter-Exchange Arbitrage

This type of arbitrage is characterized by a combination of intra-exchange and inter-exchange transactions with cryptocurrencies. The scheme for this type of arbitrage looks like this:

1. A trader buys ETH for USDT on exchange A.
2. Exchanges Ethereum to Bitcoin on exchange B.
3. Sells BTC for BUSD on exchange C.

These chains require deep market knowledge and quick reactions, so it is better to use bots when buying and selling cryptocurrencies using this scheme.

International Cryptocurrency Arbitration

This method involves the use of exchanges and currencies of different countries, and fiat money can also be involved in the transaction.

For example, traders can buy dollars at a lower rate in one country, transfer these dollars to a bank card in another country, purchase USDT and sell them in the first country at more favorable prices.

Working in different markets

Experienced traders can easily resort to arbitrage, which takes into account the difference in prices on the futures and spot markets.

When opening a position on the futures market, traders are offered different contracts – perpetual or limited to a certain time period. With strong price fluctuations on the market, such arbitrage can bring significant capital gains. As a rule, transactions are made when some significant news appears. At this time, there is often a high difference in the price of the futures contract and the spot offer.

P2P-Arbitration

P2P (from English Peer-to-Peer, person-to-person ) is money transfers directly from one trader to another.

P2P platforms such as Binance P2P are platforms where traders can create their own orders to buy or sell cryptocurrency for fiat money, while clients of P2P trading platforms can also set the rate. A trader who wants to sell or buy cryptocurrency responds to the ad and users make a direct transfer.

The essence of P2P arbitrage is that on P2P platforms the cryptocurrency rate can differ significantly from the market rate, which allows the trader to earn on the difference.

Dex arbitrage

This is arbitrage on decentralized exchanges. The features of decentralized crypto arbitrage are determined by the specifics of Dex-exchanges. Dex-arbitrage is characterized by:

• higher profit potential: Dex does not have centralized management, their work is regulated by the execution of smart contracts, which implies greater naturalness in the formation of the rate, therefore, there are more significant price fluctuations compared to centralized platforms. In addition, pricing is affected by the relatively low liquidity of assets on Dex;
• higher risk: it is caused by natural price volatility;
• Difficulties of trading automation: the peculiarities of a decentralized organization complicate the work of trading bots.

Statistical arbitrage

Statistical arbitrage is a strategy for buying and selling cryptocurrency that is based on mathematical models and statistical analysis. Mathematical and statistical algorithms are used to quickly find temporary price imbalances on different exchanges and instantly make trades.

How to Start Cryptocurrency Arbitrage: The Steps You Need to Take

To conduct arbitration transactions it is necessary:

Choose the right exchange

There is a lot of competition between exchanges, and it can be extremely difficult for an inexperienced trader to quickly and accurately find a platform for arbitrage. For potentially more effective trades, it is worth paying attention to the following parameters:

• Liquidity: the higher the trading volume offered by exchanges, the lower the risk of price slippage. Slippage is the difference between the trader’s expectations regarding the value of assets and the price at which the order is executed;
• commissions: the lower the commissions, the less losses when making transactions;
• order processing speed: the higher the speed, the greater the chances of a successful arbitrage transaction;
• Selection of trading pairs: Exchanges should include as many currency pairs as possible, mainly those that you need for arbitrage;
• Security: It is important that the exchange offers measures to protect against hacking and theft.

Find arbitrage opportunities

It is important for an arbitrage trader not to miss an opportunity to successfully buy or sell cryptocurrency.

In addition to finding the best exchange, a trader will need to track cryptocurrency prices, either manually or using various scanners and bots, such as Arby.Trade, WunderTrading, Cryptohopper, and others. It is also important to always stay up to date with the latest cryptocurrency market news. The emergence of information about new projects and events can lead to a rapid change in asset prices on some platforms, while others will be slow to adjust their prices. This will create a window for an arbitrage transaction.

Assess the risks

Before moving on to an arbitrage transaction, a trader should evaluate its profitability in terms of risks. Among the risks are volatility, technical problems and high commissions.

Benefits and Risks of Cryptocurrency Arbitrage

Any review article is supposed to cover the benefits and risks associated with a certain activity, including cryptocurrency arbitrage.

Advantages

The main advantage is high profitability in the long term. By properly organizing the arbitrage purchase and sale of cryptocurrency, traders will be able to significantly increase their capital, even if the price difference is insignificant.

Another advantage is that there is no need to predict the price of cryptocurrency. The income available to traders is based on the already existing price imbalance.

Those wishing to trade cryptocurrency using arbitrage transactions may also be pleased with the opportunity to receive passive income without complex manual actions. All that is needed for this is to set up trading bots that will independently implement transactions on one trading platform or between several exchanges.

In addition, arbitrage is a great way to diversify your cryptocurrency portfolio and hedge against volatility risks, as this type of trading involves a large number of currency pairs in transactions.

And, of course, one cannot fail to mention the quick payback, especially with significant investments.

Risks of crypto arbitrage

• high market volatility: the price of cryptocurrency can change over short periods of time. Because of this, there is a risk of losing money when transferring it from one exchange to another if the transaction coincides with a jump in the rate;
• high fees: they can significantly reduce income, especially if the difference in the exchange rate of the cryptocurrencies involved in the transaction is small;
• liquidity risk: if there is insufficient liquidity on an exchange, the trader risks not being able to exchange the cryptocurrency at the desired price;
• technical failures: due to technical problems on the exchange or in the wallet, as well as delays in the blockchain network, a trader may lose speed and miss the moment of price changes.

Tips and tricks for successful arbitrage

Our article is aimed at helping beginners master the arbitrage strategy. Here are some useful tips:

Use automated tools

All automated trading tools make trading more efficient, help achieve high arbitrage speed, scale transactions while tracking a large number of them. Automated arbitrage is also one of the ways to eliminate the human factor, such as calculation errors.

Bots monitor market data such as price differences, trading volume, etc., and look for arbitrage opportunities. They also automatically execute trades and can manage risks, such as stopping if the loss exceeds a specified value.

Keep track of and analyze transactions

Keeping records is necessary to evaluate the effectiveness of an arbitrage strategy, optimize taxation of earnings, and analyze risks.

To achieve these objectives, traders should consider:

• date and time of the transaction: this will help analyze market dynamics;
• cryptocurrency: what units were used and in what quantities;
• exchanges on which transactions were made;
• asset value, as well as exchange and network fees – to calculate profit or loss.

Exchange reports with a detailed history of transactions, as well as specialized programs such as CryptoTaxCalculator, CoinTracking and others, can help systematize the necessary data.

Conclusion

Cryptocurrency arbitrage is a great opportunity to increase capital due to the difference in the value of a crypto asset on different exchanges or within different currency pairs.

There are many arbitrage strategies: intra-exchange, inter-exchange, P2P and others. When choosing a suitable strategy, you should be guided by the depth of your own knowledge of the cryptocurrency market and your trading capabilities.

When working with arbitrage, it is important to consider market volatility, liquidity of the assets of interest, commission sizes, technical capabilities of trading, for example, the need to automate it. With the right approach, arbitrage can become an excellent addition to other trading options or turn out to be the main source of income from cryptocurrencies.