There are different strategies for trading cryptocurrencies. The most well-known are those used to trade the crypto market, like day traders. Other strategies do not require the high level of expertise that day trading requires.
Crypto arbitrage trading is one of these strategies that don’t require such high-level trading skills. However, it’s not “simple” and does require some knowledge of crypto markets. So, how does crypto arbitrage trading work?
What Is Crypto Arbitrage Trading?
If you have visited two or more exchanges around the same time, you may have noticed that the price of Bitcoin is not the same on all those exchanges. Instead, the price on one exchange is higher or lower than the other.
This phenomenon is present in every market, be it stocks, commodities, or metals. It is also present in the crypto market, hence the emergence of crypto arbitrage trading.
Crypto arbitrage trading is a crypto trading strategy that involves buying and selling crypto assets and taking advantage of the difference in prices on competing exchanges to make a profit.
Arbitrage is a strategy anyone capable of buying and selling crypto assets on exchanges can use to make a profit. It is also generally low-risk trading that requires little to no trading experience.
How Does Crypto Arbitrage Trading Work?
Arbitrage trading is all about buying and selling crypto assets from one exchange to another. Basically, you buy Bitcoin on exchange A, where the price is lower, and sell on exchange B, where the price is slightly higher.
To get a better picture of what we’re saying, visit CoinMarketCap, and select Bitcoin to see the differences in the price on different exchanges.
At the time of writing, the price of Bitcoin on Binance is $20,141, while on Huobi Global, it is $20,130. So if you buy from Huobi Global and sell on Binance, you’ll profit roughly $11 on each Bitcoin.
Note, though, that as the cryptocurrency market is highly volatile, the trade must be made very quickly, almost simultaneously, before prices change again. This may not be a problem in some arbitrage trading types, as we will see shortly.
The volatility isn’t all bad, though, as it makes arbitrage trading opportunities more abundant in the crypto market than in any other market.
4 Types of Crypto Arbitrage Trading
There are several crypto arbitrage types, depending on how the arbitrage is done and the parties involved. The following are the four major types of crypto arbitrage.
1. Inter-Exchange Arbitrage
This is the type of arbitrage trading in which you simply buy from one exchange and sell on another. It involves only two exchanges.
Since arbitrage trading of this type depends on the real-time prices of assets, it is impractical to buy assets on one exchange and transfer them to another exchange to sell.
You can get around this and transaction fees by buying and selling the asset simultaneously. This is possible if you hold assets on both exchanges.
Let’s assume you hold $20,000 worth of USDT on Binance and 1 BTC on Kraken.
If Bitcoin is worth $20,300 on Kraken but worth exactly $20,000 on Binance, you can take advantage of this opportunity by buying the Bitcoin on Binance with your $20,000 of USDT while simultaneously selling the Bitcoin on Kraken at $20,300.
Once this is completed, the $300 spread becomes profit for you, and you won’t have to pay withdrawal and deposit fees for moving the bitcoin from Binance to Kraken or vice versa.
2. Triangular Arbitrage
This type of arbitrage trading is a bit easier because it is done on a single exchange, although it involves three different assets.
Assume you hold Bitcoin, Solana, and Ethereum. If the last two assets are undervalued on the exchange, you can use this arbitrage opportunity to get more Bitcoin.
For example, you use your Bitcoin to buy Solana, then use your Solana to buy Ethereum. Finally, you use Ethereum to buy Bitcoin again, and that’s it.
You will end up with more Bitcoin than when you first bought Solana, and without sending Ethereum to another exchange and paying its high gas fees.
As it is all done on the same exchange, no withdrawal, transfer, or deposit fees are involved.
3. Statistical Arbitrage
This involves using mathematical models to trade assets and profit from price differences. Statistical arbitrage also uses arbitrage bots, which are capable of trading hundreds of assets at the same time.
The bots use mathematical models to predict if a trade will be a winning or losing one and trade based on the prediction.
As bots are involved, the process is mainly automated rather than manual, so there isn’t much for you to do. This makes it more convenient with less risk of making mistakes.
4. Spatial Arbitrage
This type of arbitrage trading takes advantage of differences in the price of an asset based on differences in the geographical locations of each exchange. It is very much like the inter-exchange arbitrage, apart from the spatial aspect.
One factor that drives spatial arbitrage is differences in demand for an asset. For example, if you live in a country with high demand for Bitcoin, you can buy from an exchange based in another country where the demand for the asset is lower and sell on local exchanges in your own country.
This will make you an instant profit as the higher demand means the Bitcoin will be worth more. Although this sounds like the inter-exchange arbitrage, you don’t have to buy and sell based on real-time prices, so you can buy from one exchange and manually transfer to the other to sell for a profit.
Pros and Cons of Crypto Arbitrage Trading
Crypto arbitrage trading has its good and bad aspects, as you might expect.
- Low-risk trading strategy that requires little experience
- Can be done during both low and high volatility
- Not many fees are involved in most arbitrage trades
- Volatility causes rapid changes in price, which may be a challenge in inter-exchange arbitrage
- May require assets on at least two exchanges
Is Crypto Arbitrage Trading Right For You?
Crypto arbitrage trading can be quite profitable if done right. It also involves very little to no risk, compared to day trading, for instance, which involves trading actual market movements.
If you have the assets to trade and meet the conditions for any arbitrage trading methods listed above, it is definitely worth trying.
The information on this website does not constitute financial advice, investment advice, or trading advice, and should not be considered as such. MakeUseOf does not advise on any trading or investing matters and does not advise that any particular cryptocurrency should be bought or sold. Always conduct your own due diligence and consult a licensed financial adviser for investment advice.