Arbitrage trading in crypto, explained

Crypto arbitrage basics

Crypto arbitrage trading is a strategy that capitalizes on price discrepancies for the same cryptocurrency across different exchanges.

Crypto arbitrage trading is buying crypto on an exchange for a specific price and selling it on another exchange for a higher price. This price discrepancy, also known as the spread, is what can lead to profit. It could be a viable alternative to traditional crypto trading in most cases, assuming you can grasp the basics.

This process is similar to buying low and selling high in the traditional stock market — only, you’re benefiting from price discrepancies on different exchanges rather than waiting for stock prices to fluctuate.

Why does this work? Crypto markets are decentralized with 24/7 uptime, compared to the traditional stock market, which is heavily regulated and only available for a limited time. As a result, cryptocurrency prices can vary across exchanges due to differences in liquidity, local demand and data sources. For instance, an exchange’s Bitcoin (BTC) liquidity and local demand impact BTC prices across exchanges. 

While the price differences might be small, frequent trades can accumulate significant profits, especially when automated systems are used.

However, please note that arbitrage is not the same as hedging. Arbitrage seeks to profit from price differences in different markets, while hedging aims to reduce risk by offsetting potential losses.

Here is a summary of differences between the two:

How crypto arbitrage works

Arbitrage trading involves buying a cryptocurrency on one exchange where it’s cheaper and selling it on another where the price is higher.

For example, if Bitcoin is listed at $85,250 on exchange A and $85,300 on exchange B, you can buy Bitcoin from exchange A, transfer it to exchange B, and sell it for profit. Of course, there are external factors to consider, like trading fees and wallet transfer times, but we’ll get into those a little later.

It’s important to note, however, that crypto arbitrage opportunities require fast action, as price volatility can get in the way of a profitable trade. Speed matters, yes.

Despite these challenges, arbitrage trading is generally considered a low-risk trading strategy when compared to other speculative trading methods. It focuses on frequent, smaller profits rather than risky, high-stakes investments.

Did you know? Despite sounding a bit legally gray, there’s nothing illegal about arbitrage trading. In fact, some argue that it’s healthy for the market, as the process keeps prices fluctuating.

Benefits and risks of crypto arbitrage for crypto arbitrage?

Crypto arbitrage benefits are low-risk due to minor price spreads and profitability in all market conditions, while risks involve market volatility, hidden fees and the reliability of exchanges.

Let’s understand the pros and cons of arbitrage trading.

Crypto arbitrage benefits

• Low-risk threshold: Due to minor price discrepancies, arbitrage is a low-risk act compared to regular trading. 
• Profitable regardless of market conditions: This focused approach means you can conduct arbitrage no matter the state of the market. It doesn’t matter if Bitcoin is $15,000 or $80,000 when you’re focused on $50 differences, as it focuses on price spreads rather than overall trends.

Crypto arbitrage risks

• Market volatility: Even if market volatility is less of a problem when it comes to arbitrage trading, the unpredictability can still cause losses if you’re not careful.
• Hidden fees: Transaction and exchange fees, speed and other charges can cut your profits if you don’t plan for them. Ensure you know all the fees you’ll pay while arbitrage trading.
• Exchange validity: Using unregulated or unreliable platforms or exchanges increases the risk of fund loss. Always prioritize secure, well-established platforms.

Did you know? Arbitrage has been around for centuries. Back when the gold standard was in place, traders would take advantage of international differences in the price of gold. This allowed them to buy gold in one country and sell it in another for profit.

Crypto arbitrage strategies

The three main types of crypto arbitrage strategies are simple arbitrage (tracking price differences across exchanges), triangular arbitrage (exploiting price gaps within a single exchange’s trading pairs) and cross-border arbitrage (leveraging regional pricing variations across international platforms).

There are three types of arbitrage trading strategies. Let’s break each one down.

Simple arbitrage

This straightforward approach involves tracking price differences between exchanges. For example, if Bitcoin is $200 cheaper on Exchange A than on Exchange B, you’d buy it on Exchange A and sell it on Exchange B for a profit.

Triangular arbitrage

This method exploits price differences within a single exchange by trading between three crypto pairs. For instance, you might trade BTC for Solana (SOL), SOL for Dogecoin (DOGE) and DOGE back to BTC. Triangular arbitrage avoids inter-exchange fees, making it cost-efficient.

Cross-border arbitrage

Cross-border arbitrage is similar to simple arbitrage — only, it involves trading across international exchanges. After all, different regulations and local demand may play a factor in pricing across platforms worldwide, and paying attention to those discrepancies can lead to profits. 

Remember that this method requires an exchange account in multiple countries, which can be difficult based on your local laws. 

Did you know? Mt. Gox, the world’s first Bitcoin exchange, was an early example of arbitrage. The platform would list Bitcoin prices with hundreds of dollars different from other exchanges, making it an ideal space for early traders to conduct arbitrage. Unfortunately, the platform came under fire for this and is still struggling to pay out its users 10 years later.

Tools for crypto arbitrage

Automated crypto trading bots streamline arbitrage by instantly analyzing price data across exchanges and executing trades via APIs, though proper setup is crucial for effective risk management.

While you can always choose to conduct arbitrage across multiple exchanges manually, you can also set up automated crypto trading bots for quicker data processing.

For instance, bots can pull price data from various exchanges in real-time and execute trades across platforms through an exchange’s application programming interface (API).

Just remember that bot automation takes a bit of time and effort to get it right — an essential part of risk management in crypto trading. You can choose to manually create a bot or rent pre-built bots from reputable sources. Either way, bots are a decent way to try and generate arbitrage profits in crypto.

Additionally, arbitrage alert tools can keep an eye on prices for you and send notifications when there’s a chance to make a profit. They make it easy to jump on opportunities without constantly checking prices. Similarly, platforms like CoinMarketCap and CoinGecko show you crypto prices from multiple exchanges in one place. They can help spot price differences quickly and find arbitrage chances.

Finally, blockchain explorers and analytics tools can give you insights into transaction data and market liquidity. They help you see the bigger picture and find arbitrage opportunities based on onchain activity.