What Is Crypto Arbitrage and Should You Get Started?
“Arbitrage” is the process of buying a good on one market and selling it at a slightly higher price on another market. To use a real-world example, imagine that you find an expensive watch at a yard sale. The watch is greatly underpriced so you buy it and sell it on eBay at a higher price. You’ve bought it cheap on one market (the yard sale) and sold it for a profit on another (eBay). Crypto arbitrage uses this same process but on cryptocurrency exchanges. A trader will buy a cryptocurrency on one exchange and instantly sell it at a slightly higher price on another exchange.
In general, crypto arbitrage is seen as a low-risk way to profit from cryptocurrency. However, it also requires a lot of time and a high volume of trades. Let’s take a closer look at how crypto arbitrage works.
Types of Crypto Arbitrage
There are five common forms of crypto arbitrage:
- Cross-exchange arbitration: This is when a trader attempts to profit off the price differences across different exchanges. It works like this. Let’s say a trader notices that Bitcoin is selling for $45,000 on Coinbase and $45,200 on Crypto.com. They could buy one Bitcoin on Coinbase and quickly sell it on Crypto.com. This would net them $200, minus any fees and transaction costs.
- Spatial arbitrage: This is a type of cross-exchange arbitrage trading that takes advantage of different regions. For example, a trader might search through exchanges in the U.S. exchange and exchanges in European in hopes of finding price discrepancies. This strategy works well since 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 discrepancy of one or two cryptocurrencies. For example, a trader might trade from Bitcoin to Ethereum to Cardano, and back to Bitcoin. Along the way, he profits from price discrepancies between the assets.
- Decentralized arbitrage: This strategy takes the same general concept and applies it to centralized and decentralized exchanges. Essentially, a trader will search for price discrepancies between these two types of exchanges. This strategy works because centralized exchanges use different strategies for pricing assets than decentralized ones.
- Statistical arbitrage: This is a complicated strategy that uses mathematical models and trading bots. These bots execute automated trades in bulk in order to maximize profit.
At the end of the day, any of these strategies will work. The most important thing is that you identify price differences between cryptocurrencies.
With that in mind, let’s take a look at the pros and cons of crypto arbitrage.
Pros of Crypto Arbitrage
- Timing: With crypto arbitrage, you make money when you make the trade. The bulk of the work is finding an arbitrage opportunity. But, once you do, the trade only takes a few seconds. For some traders, this is greatly preferable to waiting for the price of an asset to move as it gives them more control.
- Low risk: Crypto arbitrage is seen as a low-risk strategy since the trades are performed 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 are most likely only profiting a few bucks on each trade, you need a lot of them to be profitable. However, these small wins can add up over the long run.
- Plenty of opportunities: Despite what it may seem, the cryptocurrency markets are still very young. This means there is still plenty of opportunity for crypto arbitrage, especially with newer cryptos. For example, ApeCoin is a brand new cryptocurrency behind the incredibly-popular Bored Ape NFT collection. In the first few days of trading, its price fluctuated by almost 1,000%.
As we know, no investing strategy is perfect. Let’s take a look at a few of the cons of crypto arbitrage.
Cons of Crypto Arbitrage
- Requires lots of work upfront: With crypto arbitrage, the bulk of the work is done before the trade. Finding price discrepancies can be difficult and there is no guarantee that you’ll find one. As cryptocurrency becomes mainstream, arbitrage opportunities will likely become harder to find.
- Fees: Trading and transfer fees can add up quickly. This can eat into your margins and reduce the profitability of your venture.
- Requires high volume: Your profit per trade will likely be fairly small. To make up for this, you’ll have to place lots of trades to earn a high return.
- Cryptocurrency risk: In general, cryptocurrencies are still seen as speculative and risky. They are not regulated, so you will have little recourse in the event you are scammed or defrauded. Due to this, trading cryptocurrencies is inherently risky.
By this point, bigger cryptocurrencies like Bitcoin and Ethereum have become a little more stable. Bitcoin has a market capitalization of nearly $1 trillion, which puts it among the world’s biggest assets. The more popular a crypto is, the more widely offered it will be. For bigger cryptos like Ethereum and Bitcoin, there is not as much potential to find price discrepancies. If you want to get started in crypto arbitrage, your best bet is to focus on smaller cryptos.
There are plenty of newer cryptos out there whose prices still move over 50% in a day. This is where the best arbitrage opportunities will be.
Another piece of advice is to try and come up with a unique strategy. If you read about a strategy online and try to copy it, there’s a good chance people are already using it. This will make it more difficult to find opportunities. Coming up with a unique system that works best for you is one of the best ways to be successful. Over time, you can learn from your mistakes and hone your strategy.
Finally, remember that there are thousands of cryptos being traded globally 24/7. Trying to search through all of these will be overwhelming. Instead, try to niche down to a specific cryptocurrency that works for you. Becoming an expert in just one crypto can help you spot arbitrage opportunities much more quickly. With trading, even just a few seconds can be the difference between making or losing money.
I hope that you’ve found this article valuable in learning more about crypto arbitrage. Please remember that I’m not a financial advisor and am just offering my own research and commentary. As usual, please base all investment decisions on your own due diligence.