“Arbitrage” is the process of buying a good in one market and selling it at a slightly higher price in another market. To use a real-world example, imagine you find an expensive watch at a garage sale. The watch is very undervalued, so you buy it and resell it on eBay for a higher price. You bought it cheap on one market (the garage sale) and sold it for a profit on another (eBay). Crypto arbitrage uses this same process but on cryptocurrency exchanges. A trader will buy cryptocurrency on one exchange and instantly resell it at a slightly higher price on another exchange.
In general, crypto arbitrage is considered a low-risk way to profit from cryptocurrency. However, it also requires a lot of time and a high volume of transactions. Let’s take a closer look at how crypto arbitrage works.
Types of crypto-arbitrage
There are five common forms of crypto-arbitrage:
- Cross Arbitrage: This is when a trader tries to take advantage of price differences between different exchanges. It works like this. Suppose a trader notices that Bitcoin is selling for $45,000 on Coinbase and $45,200 on Crypto.com. They could buy a bitcoin on Coinbase and quickly resell it on Crypto.com. This would earn them $200, less fees and transaction costs.
- Spatial arbitration: It is a type of cross arbitrage trading that takes advantage of different regions. For example, a trader might search the US and European exchanges hoping to find price discrepancies. This strategy works well because different regions have different supply and demand rates for cryptos.
- Triangular Crypto: This is a more complicated method of crypto arbitrage. It involves using two or three different assets to take advantage of the price differential of one or two cryptocurrencies. For example, a trader can trade from Bitcoin to Ethereum to Cardano, and back to Bitcoin. Along the way, it takes advantage of price discrepancies between assets.
- Decentralized arbitration: This strategy takes the same general concept and applies it to both centralized and decentralized exchanges. Essentially, a trader will be looking for price discrepancies between these two types of trades. This strategy works because centralized exchanges use different asset pricing strategies than decentralized ones.
- Statistical arbitration: It is a complicated strategy that uses mathematical models and trading robots. These bots execute automated trades en masse to maximize profits.
Ultimately, each of these strategies will work. The most important thing is that you identify the price differences between cryptocurrencies.
With that in mind, let’s take a look at the pros and cons of crypto arbitrage.
Benefits of Crypto Arbitrage
- Hourly: With crypto-arbitrage, you earn money when you make a transaction. The bulk of the work is finding an arbitrage opportunity. But, once you’ve done that, the trade only takes a few seconds. For some traders, this is much better than waiting for an asset’s price to move, as it gives them more control.
- Low risk: Crypto arbitrage is considered a low risk strategy because trades are made very quickly. This limits your exposure to price fluctuations.
- It can be lucrative: In general, crypto arbitrage requires a lot of small wins. Since you probably only make a few dollars on each trade, you need a lot to be profitable. However, these small victories can add up in the long run.
- Many opportunities: Despite what it may seem, the cryptocurrency markets are still very young. This means that there are still plenty of opportunities for crypto arbitrage, especially with newer cryptos. For example, ApeCoin is a brand new cryptocurrency behind the incredibly popular Bored Ape NFT collection. During the first days of trading, its price fluctuated by almost 1000%.
As we know, no investment strategy is perfect. Let’s take a look at some of the disadvantages of crypto arbitrage.
Disadvantages of Crypto Arbitrage
- Requires a lot of work upfront: With crypto arbitrage, the heavy lifting is done before the trade. Finding price discrepancies can be difficult and there is no guarantee that you will find one. As cryptocurrency becomes more mainstream, arbitrage opportunities will likely become harder to find.
- Costs: Trading and transfer fees can add up quickly. This can eat into your margins and reduce the profitability of your business.
- Requires high volume: Your profit per trade will probably be quite low. To compensate for this, you will have to place many trades to get a high return.
- Cryptocurrency Risk: In general, cryptocurrencies are still considered speculative and risky. They are unregulated, so you will have little recourse in the event of a scam or fraud. For this reason, trading cryptocurrencies is inherently risky.
At this point, larger cryptocurrencies like Bitcoin and Ethereum have become somewhat more stable. Bitcoin has a market capitalization of nearly $1 trillion, which places it among the largest assets in the world. The more popular a crypto is, the more widely it will be offered. For bigger cryptos like Ethereum and Bitcoin, there is not as much potential to find price gaps. If you want to get into crypto arbitrage, your best bet is to focus on smaller cryptos.
There are many newer cryptos whose prices are still moving more than 50% in a day. This is where the best arbitrage opportunities will be.
Another tip is to try to find a unique strategy. If you read about a strategy online and try to copy it, chances are people are already using it. It will then be more difficult to find opportunities. Finding a unique system that works best for you is one of the best ways to succeed. Over time, you can learn from your mistakes and refine your strategy.
Finally, remember that thousands of cryptos are traded around the world 24/7. Trying to search through it all will be overwhelming. Instead, try to focus on a specific cryptocurrency that works for you. Becoming an expert in a single crypto can help you spot arbitrage opportunities much faster. With trading, even a few seconds can be the difference between making or losing money.
I hope you found this article useful in learning more about crypto arbitrage. Remember that I am not a financial adviser and simply offer my own research and commentary. As usual, please base all your investment decisions on your own due diligence.
A graduate of the University of Miami, Teddy studied marketing and finance while playing four years on the football team. He has always had a passion for business and has used his experience from a few personal projects to become one of the top rated business writers on Fiverr.com. When he’s not pounding words on paper, you can find him pounding notes on the piano or traveling to a random location.