Cryptocurrencies can be bought and sold on over 500 exchanges around the world. All exchanges have their own rates for all the (crypto)markets they are in. So as you can imagine, there are many price differences around the world.
Which exchange would be best to buy crypto on when it comes to prices? Ever heard of arbitrage? What is crypto arbitrage? When does crypto arbitrage occur and how can you benefit from arbitrage? In this blog I will discuss crypto arbitrage and I will use an example to demonstrate arbitrage.
What is crypto arbitrage?
If you visit three different exchanges and compare the price of bitcoin, you will find three slightly different prices.
Cryptocurrencies like Bitcoin are traded on hundreds of different decentralized exchanges. Sometimes the price of bitcoin (or other cryptocurrency) on one exchange may differ from that on another.
With crypto arbitrage, investors seize the opportunity for a cryptocurrency to trade at a lower price on one exchange by buying this cryptocurrency and then immediately selling it for a higher price on another exchange. This can generate profit.
Types of arbitrage
Spatial arbitrage
Spatial arbitrage entails the trading of virtual currencies on two different exchange platforms. Spatial arbitrage is a very simple way to perform crypto arbitrage (buy crypto on one exchange and transferring it to another exchange to sell it).
This is a simple tactic that can be used to take advantage of price differences between cryptocurrencies across various exchange platforms. But this form of arbitrage does create risks such as transfer times (when transferring crypto from platforms A to B) and costs associated with the transfer.
Spatial arbitrage without transferring
Some traders try to avoid the risks that come with spatial arbitrage. These risks can be avoided by, for example, going long bitcoin on one exchange and short on another. The traders wait for the prices of bitcoin to converge on both exchanges. This saves the trader from having to transfer the cryptocurrency from one exchange to the other. The trader avoids costs in this way.
Triangular arbitrage
The best way to explain triangular arbitrage is through an example. Suppose person A has USD and uses it to buy BTC in a BTC/USD market. Person A has bought BTC with his money. Next, person A buys LTC in a BTC/LTC market. Finally person A sells LTC for USD on an LTC/USD market. If the prices of BTC and LTC are advantageous, you can get more USD at the end than what you originally started with.
If a triangular arbitrage opportunity is used, person A ends up with 1,026.84 BTC (1,000 x 0.032 / 6.97 x 223.66). The value of this triangular arbitrage is 26.84 BTC. By executing this arbitrage opportunity, person A increases its BTC holdings. Pretty sweet!
Manually or with a bot?
It is difficult to manually exploit arbitrage strategies, but there are tools that make it possible. Using a bot is very useful because it spots opportunities that you won't see manually or is too labor intensive. There are many possibilities for bots. My advise is to research and test some of the bots yourself.
There are also a number of apps that investors can download that track the prices of cryptocurrencies for arbitrage opportunities. In this way, investors can take advantage of algorithms that automatically scan for arbitrage across different crypto exchanges. This automated approach can allow traders to take advantage of multiple different price discrepancies.
Risks of crypto arbitrage
Losses
If investors want to succeed in crypto arbitrage, investors need to execute the trades quickly to take advantage of price differences from exchange to exchange while those differences are still profitable. If you are too late, you will not be able to take advantage of this opportunity. Bots help with this.
Trading volume
The crypto exchanges work in such a way that the price of a cryptocurrency is based on the last trade on that exchange. It is worth noting that not all crypto exchanges are equal in trading volume. Some crypto exchanges have huge trading volumes while other exchanges are not as active and the trading volume is a lot lower. The trading volume is important because it affects the liquidity and available prices of a particular exchange.
A crypto exchange with low volume may lead to the situation where that exchange cannot execute a trade large enough to seize the profit. Low volume exchanges may also lead to a longer time period before a trade is executed to seize a pricing opportunity.
Transaction costs
Buying and selling cryptocurrencies involves transaction costs. Each exchange has different transaction costs. So it is very important to keep an eye on these costs.
Fraud and hacks
Because crypto is largely unregulated, the risk of fraud and hacks is present. Storing your crypto currency safely is of utmost importance. I wrote a blog about this before. Click here.
Last remarks
Arbitrage can be a great strategy if you are involved in day trading of crypto. But be aware that there are advantages, disadvantages and great risks. Weigh the risks carefully before committing to crypto arbitrage. A bot is a great way to seize arbitrage opportunities.
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BTC address: bc1q3nnm8m2vrsv8med8a38dl37g8l3mm4wa7ph7wj
ETH address: 0x38b84E2D3B50F83A067A7488C1733180651f418A
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