When it comes to trading cryptocurrencies, you can take a number of different approaches. One such strategy that does not necessitate expert-level trading knowledge is crypto arbitrage trading. Although it does require some familiarity with crypto markets, it is not an “easy” process.
Cryptocurrency markets feature dozens of separate exchanges, all of which list different values for the same cryptocurrencies. This creates a new avenue for skilled traders who aren't afraid of taking a chance to get an advantage over their peers: betting on the performance of these exchanges against one another. Let’s find out how this works.
How Does Crypto Arbitrage Work?
Arbitrage is a trading method that involves buying an asset at one market's price and then selling it at a higher price in another market. Using this method, you can profit from the market inconsistencies that exist between cryptocurrency exchanges. Say an asset is valued at $15,000 on Coinbase; it might be listed at $14,600 on Binance. A trader can make a profit by buying it on Binance, sending the asset to Coinbase, and then selling it.
Types of Crypto Arbitrage
This type of crypto arbitrage involves buying a cryptocurrency on one exchange and then selling it on another for a profit. However, there are a couple issues with this approach. While spreads may only last for a few seconds, moving funds between markets could take several minutes. The issue of transfer fees arises because of the costs associated with transferring cryptocurrency from one exchange to another.
It entails making use of mathematical models to trade assets. The use of arbitrage bots, which can trade hundreds of assets simultaneously, is also common in statistical arbitrage. Mathematical models are used by the bots to determine the likelihood of a trade's success or failure. With bots in the picture, the process is largely automated and devoid of human involvement. To put it another way, this lowers the barrier to entry and makes for easier navigation.
By comparing the prices of an item on several exchanges in different places, this form of arbitrage trading helps traders profit from price discrepancies. Spatial arbitrage can be prompted by demand disparities for a given asset. For instance, if you reside in a nation where Bitcoin is in great demand, you may buy from an exchange situated in a nation where Bitcoin is in lower demand and then sell on local exchanges in your locality.
Because of the increased demand, the price of Bitcoin will increase immediately. This may sound similar to inter-exchange arbitrage, but it does not require you to buy and sell at the exact same time. Instead, you can buy on one exchange and transfer your funds to the other so that you can sell on the other at a higher price.
Even though it comprises three distinct assets, this form of arbitrage trading is simplified by the fact that it takes place on a single exchange. For example, you have some BTC, SOLA, and ETH. It is possible to profit from arbitrage if the last two assets are discounted on the exchange.
Bitcoin can be used to purchase Solana, which can then be used to purchase Ethereum. Last but not least, you can use Ethereum to repurchase Bitcoin. You can avoid the hefty gas costs of moving Ethereum to another exchange and yet end up with more Bitcoin than you did before you bought Solana.
Decentralized exchanges and AMMs, which use smart contracts to determine the prices of cryptocurrency trading pairs, frequently provide opportunities for arbitrage. Arbitrage traders can execute cross-exchange trades between the decentralized exchange and a centralized exchange if the prices of cryptocurrency trading pairs fluctuate significantly from their spot values on centralized exchanges.
Risks of Crypto Arbitrage
Slippage happens when a trader places a buy order for a cryptocurrency that is larger than the cheapest offer on the order book, resulting in the order being filled at a higher price. With such slim margins, slippage can easily wipe away any profits a trader might have made.
Price Fluctuations may pose a threat to arbitrage investors. Spreads arise very quickly and can evaporate just as quickly, so traders need to act quickly to take advantage of them.
Finally, investors need to think about transfer fees. For the most popular cryptocurrencies, spreads aren't too high, and a high transfer or transaction charge can quickly wipe out any profit. Because of the small margins available, a trader who wants to make a living in the market must engage in a great deal of activity.