Crypto Arbitrage in 2022: What You Need to Know

Cryptocurrencies have positioned themselves as a powerful innovation. And over the years, many profitable opportunities have emerged from it, increasing its popularity and adoption.

Today, more than 8,000 crypto assets are in the market and are trading on multiple exchanges. The price gaps on these assets on every exchange presented an opportunity known as Crypto Arbitrage. While cryptocurrency prices are volatile, such volatility is an advantage in crypto arbitrage.

What is Crypto Arbitrage?

Crypto arbitrage is a form of cryptocurrency trading. It is simply about taking advantage of the price differences of an asset on different exchanges.

The most common trading strategy is to buy an asset on the exchange and sell it back when a profit has been made. However, crypto arbitrage allows traders to buy on one exchange and sell on another due to a noticeable price discrepancy. For example, if Bitcoin is trading at $30,000 on Binance and $30,100 on Kucoin, a $100 arbitrage opportunity is available in such a scenario. Ripple is also one of the good options for trading as its low price is more affordable in line with the XRP AUD chart. You can start trading now using any crypto trading platform. One of the most convenient for Australian users is the TimeX platform.

Yet, crypto arbitrage is not as simple as buying on one exchange and selling on another. Just like regular crypto trading, crypto arbitrage comes with risks that traders should be aware of before venturing into it.

How does crypto arbitrage work?

Arbitrage is common in all financial markets and is not native to cryptocurrency. The practice is centuries old, especially in traditional markets like stocks, bonds and commodities. For example, the price of a stock on the New York Stock Exchange may vary on the Tokyo State Stock Exchange.

Crypto arbitrage takes the same form, with cryptocurrency as the primary asset. Traders exploit price differences – also known as spreads – on crypto assets to their advantage. However, they usually need to be timely as the price gap may not last long. A delay in selling the asset at a higher price on the other exchange could result in an unexpected loss.

Besides the volatility of cryptocurrencies, other factors are usually responsible for the arbitrage opportunities that traders capitalize on. An exchange with low fees, higher trading volume, and liquidity usually has lower crypto prices.

Another thing to note is that most exchanges value a cryptocurrency based on the most recent transaction, which can be a buy or sell order. A savvy crypto arbitrageur will study these metrics to position themselves for a profitable trade.

Types of crypto-arbitrage

In crypto arbitrage, there are different types of opportunities available. Types of crypto arbitrage include;

Cross Arbitrage: This is the most basic form of arbitrage trading, where a trader attempts to earn by buying cryptocurrency on one exchange and selling it on another at higher prices.

Spatial arbitration: Another type of cross arbitrage trading is spatial arbitrage. The main difference is that the exchanges are spread across the country. By using the geographic arbitrage strategy, you can take advantage of the difference in demand and supply for bitcoins in America and South Korea, for example.

Triangular arbitration: It is the process of rotating funds between three or more digital assets on a single exchange to take advantage of a price difference between one or two cryptocurrencies. A trader can, for example, set up a trading cycle that starts with bitcoin and ends with bitcoin.

A typical example of triangular arbitrage might be a Bitcoin-to-Ether trade, followed by an Ether-to-XRP trade. A final exchange from XRP to Bitcoin completes the cycle. Usually, if there are price gaps between the three trading pairs, a trader will end up with more bitcoins than they started with. Thus, he can sell to earn profits on his initial investment. On the other hand, a negative price difference would lead to having less bitcoins, with a loss accumulating when selling.

Statistical Arbitration:

Traders using this arbitrage strategy frequently use statistical models and trading robots to perform high frequency arbitrage trades and maximize profits. Trading bots are computer-assisted trading systems that execute many trades in a short time using pre-programmed trading strategies.

Decentralized arbitration

This arbitrage opportunity is prevalent on decentralized exchanges or automated market makers (AMMs), which use automated, decentralized programs called smart contracts to discover the price of crypto trading pairs.

Arbitrage traders can leverage and execute cross trades between the decentralized exchange and a centralized exchange if the prices of crypto trading pairs on the former differ significantly from their spot prices on the centralized exchanges.

Is Crypto Arbitrage Legal?

As a general rule, crypto-arbitrage is not an illegal practice. While there are no express laws governing crypto arbitrage, some local laws require traders to pay tax on their crypto earnings, including filing a crypto investment report, which they can use to calculate Taxes. Additionally, arbitrage enables market efficiency for cryptocurrency.

Why is Crypto Arbitrage considered a low risk strategy?

The risk exposure of crypto arbitrage is low compared to other crypto trading strategies. Trading strategies like day trading require traders to predict an uptrend in an asset, which can lead to losses if the prediction is wrong.

Crypto arbitrage is different because traders do not need to analyze the market. They spot opportunities that are executed within seconds or minutes. Nevertheless, crypto-arbitrage carries special risks.

Crypto Arbitrage Risks

The cryptocurrency market is volatile and there are risks unique to every investment and trading strategy, including crypto arbitrage. What are the risks involved in carrying out arbitration transactions? These risks could have a significant impact on a trader’s chances of profiting from a trade. They understand;

Costs

When performing cross arbitrage, traders need to consider trading, withdrawal and deposit fees, which can impact the expected profits on the trade.

Arbitrage traders can avoid this risk by limiting their trades to exchanges with competitive fees. Additionally, they may also engage in triangular arbitrage trading, which involves transacting within an exchange.

Volume

The higher the trading volume of a cryptocurrency, the higher its liquidity, which increases the likelihood of trades being executed.

Slippage

When entering or exiting a trade, a trader may get a different price than expected. This is called price creep. And this is common with decentralized arbitration. Therefore, rigorous market research and excellent market timing become essential parts of arbitrage trading.

Security

Arbitrage traders are vulnerable to security issues related to exchange hacks and exit scams, as they have to deposit large sums of money in exchange wallets. Exit scams occur when a crypto exchange abruptly ceases operations and disappears with traders’ funds. Thus, it is good to do your homework and stick with reliable crypto exchanges.

Conclusion

Arbitrage is one of the many opportunities available in the crypto market. However, it is considered a low risk trading strategy. Arbitrage traders can also capitalize on bots to automate the whole process.

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