Crypto Intermediate

What is crypto arbitrage trading, and how to use it

crypto arbitrage trading

Key Takeaways

  • Crypto arbitrage involves buying and selling crypto across different exchanges to profit from the price differences between them.
  • Deterministic arbitrage is the most common type of crypto arbitrage, but more experienced traders can opt for triangular arbitrage too.
  • Check the transaction fees associated with the platforms you intend to use to ensure that arbitrage trading is profitable.

Everyone tells you to buy low and sell high. What they usually don’t tell you is how long you will have to wait after buying in. While HODLing is a relatively safe strategy, the wait gives room for suspense and the building up of anxiety. If the waiting game is not your cup of tea, crypto arbitrage could be what you are looking for.

What is cryptocurrency arbitrage trading?

Crypto arbitrage is a low-risk trading strategy where you buy crypto on one exchange and then quickly sell it on another for a higher price. The arbitrage approach uses the discrepancy in prices across exchanges to generate profit for the trader. So if BTC is selling for ₹15,00,000 on exchange A and for ₹15,02,500 on exchange B, you could use this trading method to walk away with a profit of ₹2,500.

To employ this trading strategy, you do not need to necessarily have a separate wallet linked to both of these exchanges. There are some platforms like CoinSwitch Pro that let you buy crypto on one exchange and sell it on another for a profit with a single login. With the Pro version of our app, you could trade across other exchanges like WazirX and CoinDCX too.

What causes prices to vary across exchanges?

Crypto prices can vary between exchanges due to a variety of reasons. This is where you understand why it happens better. Here are some relevant factors to consider.

  • The lack of standard pricing: The number of buyers and sellers on an exchange fluctuates based on a variety of factors. If an exchange has more buyers and sellers than others at some point in time, it will have greater liquidity. Liquidity is the ease with which you can buy and sell the asset you know. Buying crypto from an exchange with high liquidity is therefore expected to give you a better price. With arbitrage, you could sell crypto on a platform with fewer buyers and sellers and a higher price.
  • The type of exchange: There are many types of exchanges available in the market. While some exchanges prefer retail investors, others focus on institutional investors. The liquidity of the latter variety of exchanges is on the lower end of the spectrum, so prices are too.
  • Geographical factors: Currency rates change while establishing cross-border trading pairs. This causes prices to fluctuate. Additionally, the regulations of a specific jurisdiction can also impact prices.

That said, remember, time is of the essence in crypto arbitrage trading. The difference between exchanges can only be exploited when you can execute two or more trades at once. If the trades are not executed simultaneously, it isn’t arbitrage.

Types of crypto arbitrage strategies

As simple as the crypto arbitrage strategy may sound, there are many ways to implement it. Some of them are discussed below.

Deterministic arbitrage

This is the simplest method of crypto arbitrage. Deterministic arbitrage trading involves simultaneous asset buying and selling between exchanges. This method lets you use existing cross-exchange price differences to generate profit.

Triangular arbitrage

This form of arbitrage uses multiple hops or, rather, an arbitrage loop across exchanges. It enables traders to profit from price discrepancies as well as trading pair price differences. Given the time factor, the loop usually involves not more than three cryptos. Hence the name.

For example, a trader may start with, say, BTC and then exchange it for ETH. The ETH could then be switched with MATIC, which is finally converted back to BTC. This way, the price difference between trading pairs is exploited so that you retain your BTC while earning a profit.

Spatial arbitrage

Trading arbitrageurs—people who arbitrage trade in crypto—tend to like this trading strategy. They prefer this because spatial arbitrage reduces transfer costs and time. Simply put, spatial arbitrage is all about using geography or country-specific differences in prices to one’s advantage.

Some countries like South Korea, for instance, have banned investors from accessing exchanges that do not operate from the country. As a result, BTC’s price there is always a little higher than in the rest of the world—a difference which has come to be known as the Kimchi Premium. Traders regularly use this to their advantage.

Statistical arbitrage

This method uses bots and data models to use arbitrage trading opportunities in bulk. By automating the trading process, this strategy allows the arbitrageur to deploy multiple trade orders within minutes. Quantitative trading firms use such statistical trading bots to maximize earnings.

Decentralized arbitrage

This strategy is used to engage in arbitrage trading crypto on DEXes like Balancer, Curve, or even UniSwap. It involves buying or short-selling assets in bulk and immediately squaring off the position at another DEX.

How to take advantage of crypto arbitrage algorithmically

Crypto arbitrage opportunities come in plenty. However, it is hard to track and leverage them. Algorithms can help boost your chances of spotting differences in prices, however marginal. While doing this, they also factor in transaction fees, exchange fees, different currency rates, and risk-to-reward ratio.

To sum it up, arbitrage algorithms are like bots that scan multiple exchanges and alert you when there is a good arbitrage opportunity. They help calculate the cost of taking a risk and estimate the chances of success.

  • Given the variety of algorithm-powered bots available, it is important to look at the following key features while choosing one:
  • Look for variants with preloaded strategies and rave reviews.
  • The ones that have been used the most may be a safer bet.
  • The trades executed per second can also be a good estimate of their popularity and reliability. Bots that have options for customization are usually better than static ones.

How to find a crypto arbitrage opportunity

Even though arbitrage in crypto is all about finding the right buy and sell price across exchanges, there is a lot more to the research that goes into the process. Here are some of the aspects that you must be mindful of before proceeding:

1. Transaction costs

While arbitrage needs you to quickly compare and initiate prices across exchanges, you don’t want to pay huge transaction costs or withdrawal/deposit overheads. So check the relevant rates beforehand and adjust the amount you want to trade accordingly.

2. Trading volume

If you plan on taking the trading across exchanges route, remember to check trading volumes before proceeding. The higher the volume, the better the liquidity, and that, in turn, boosts the chances of your trades getting executed—especially the sell variety.

3. Custodial risks

You might want to store your crypto on an exchange to avoid the lags associated with deposits and withdrawals. Always rely on well-known exchanges to protect yourself from hacks.

4. Risks of crypto arbitrage

Arbitrage trading comes with its own risks and dangers. Let’s discuss some of them below to help you decide whether arbitrage is for you.

5. Platform-related bottlenecks

You might have the best arbitrage trading strategies in place, but execution issues can always show up. These could include anything from funds getting stuck to exchange rates not showing up. Should this happen, you will not be able to profit from the fleeting price difference and may even have to sell lower to free up the funds.

In addition, arbitrage traders might also find it hard to navigate insufficient volume, time constraints, and high platform-specific fees.

6. Sudden liquidity crunches

Global events like fed rate hikes, exchanges declaring bankruptcy, and more can cause volatility surges, changing the prices of your crypto assets of choice without prior intimation.

Remember when the FTX hacker took to dumping crypto assets (primarily ETH) across exchanges? On-chain analytics platform Lookonchain reported that they dumped almost 50,000 ETH.

Unprecedented dumps such as this can immediately impact the liquidity of a crypto asset and pose significant risks to your arbitrage trading strategies.

Why crypto asset arbitrage is a low-risk strategy

Crypto arbitrage is a low-risk strategy because you do not need to bet on the future prices of any crypto. Instead, all you need to know is the difference in crypto prices across exchanges. This strategy, therefore, spares you of the uncertainty involved in dealing with market volatility.

However, to make it big in arbitrage, experience is the key. You need to do a lot of research to zero in on the type of arbitrage strategy you are most comfortable with. This further ensures that the risks you take are fewer.

Getting good at arbitrage: Quick tips

  • Anyone can try their hand at crypto arbitrage. But it is important to bear the following things in mind if you plan to use this strategy.
  • Expose yourself to multiple exchanges to tap into several price difference combinations.
  • Work toward increasing the speed with which you enter and exit trading positions. This will ensure you get the deal you want before the prices change. Choosing a platform carefully also goes a long way in securing a hassle-free experience.
  • Focus on less popular crypto assets as the trading volumes and price spread for those will vary more.

And, of course, don’t forget to check out CoinSwitch Pro as you begin your arbitrage trading journey!

FAQs

What tools are useful for crypto arbitrage?

For crypto arbitrage, tools like CoinGecko, CoinMarketCap, and CryptoCompare help track prices across exchanges. Automated trading bots such as HaasOnline and Cryptohopper can execute trades swiftly. Always research, test, and use reputable tools cautiously.

Which cryptocurrencies are suitable for arbitrage?

Cryptocurrencies with higher trading volumes and price disparities between exchanges are suitable for arbitrage. Examples include Bitcoin (BTC), Ethereum (ETH), Litecoin (LTC), and stablecoins like Tether (USDT). Research and monitor price differences before arbitrage attempts.

How much capital is needed for crypto arbitrage?

The amount of capital needed for crypto arbitrage varies based on factors like trading fees, price differences, and the number of trades. Starting with a substantial amount can yield better results, but consider risks and plan within your financial capacity.

Can beginners engage in crypto arbitrage?

Yes, beginners can engage in crypto arbitrage, but it requires understanding of exchanges, fees, and market movements. Start small, research well, and gain experience over time. Be cautious, as arbitrage involves risks and complexities.

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