What is cryptocurrency arbitrage?
Arbitrage can be defined as buying of one asset on a different market and selling it in another market for a higher price. In cryptocurrency arbitrage, you can search and compare the price of coins in different exchanges. You then buy from the cheaper exchange and sell in the exchange where the price is higher. You will then have the price difference as your profit.
Arbitrage has been in existence in foreign exchange markets for long but has been out of reach due to massive developments in quantitative systems. Cryptocurrency arbitrage is, however, possible due to the rapid surges in trading volumes and inefficiencies in exchanges which cause differences in price.
In most chances, big exchanges that have high trading traffic direct the price of coins in smaller exchanges with fewer trade volumes. However, there are always changes that the prices are different on the exchanges. This is where cryptocurrency arbitrage is possible.
How cryptocurrency arbitrage is performed
For starters in cryptocurrency arbitrage, the most common and easy way to approach it is through manual monitoring. Take a look at the prices of your preferred cryptocurrencies, monitor their prices on different exchanges, place your trades then transfer the funds accordingly.
There are also cryptocurrency arbitrage bots that have been created to monitor the prices movements and differences of coins in the market. Additionally, mobile trading apps can also help in the monitoring process to help you keep note of any changes that can help you make a profit.
Types of cryptocurrency arbitrage
- Pricing
The prices of coins are different on different exchanges. Coinlib has a service specifically designed for arbitrage called best price explorer. Here, there is a list of all exchanges for a specific market with a rank from the most expensive to the least expensive. Through best price explorer, you can decide if you will explore cryptocurrency arbitrage depending on your chances for profit.
In order to explore price arbitrage, you should consider
- Fees for trading a coin
- Fees for depositing or withdrawing a coin
- Blockchain network fees
- Time taken to move a coin from one exchange to another
If all these options show that you can earn a profit with arbitrage, then you can go ahead and make the trade. Remember that arbitrage highly depends on time hence it is not a permanent opportunity to make a profit. If a lot of time is required for your trade to be confirmed, the price might change affecting the risk.
- Geography
The supply and demand of cryptocurrencies in a certain country might make their prices different from the rest of the world. For instance, last year saw the price of Bitcoin in Zimbabwe skyrocket as the supply and demand did not match. A lot of people preferred transacting in BTC due to the volatile nature of their local currency. Also, their wanted to store their money in Bitcoins as their currency was experiencing inflation.
This could be a huge chance for cryptocurrency arbitrage. Buying from an exchange in a different country and selling to people in countries where the price is very high can help you make a profit. You should, however, be cautious of any legal regulations against cryptocurrencies as well as withdrawal limitations that can affect your trade.
- Listing
The demand for coins usually goes up once they get listed on exchanges. Moreso, when they get listed on large exchanges, they pose a high chance for cryptocurrency arbitrage that you can explore. For example, when a coin gets listed on an exchange like Binance, it experiences a growth in value and a lot of people want to buy it. Buying from other smaller exchanges and selling on Binance at the higher price is an example of cryptocurrency arbitrage.
Strategies
As a cryptocurrency arbitrage trader, there are different strategies you can use to make a profit. These include;
- Convergence arbitrage
This strategy is similar to using pricing arbitrage. As a trader, you take advantage of differences in prices on exchanges by buying where a coin is undervalued and short-selling it in an exchange where it is overvalued. You make a profit from the amount of convergence when the two separate prices meet in the middle.
- Simple arbitrage
This strategy involves just one coin. This is where you buy a coin and sell it immediately on a different exchange to make a profit.
- Triangular arbitrage
You use this strategy by taking advantage of the price difference of a coin between three currencies. The price of BTC in USD can be different to EUR and YEN. So you can buy BTC in USD, and then sell the BTC to make EUR. You then exchange the EUR you have made back to USD. It is not as complicated as I have made it look. The three currencies are BTC, USD and EUR.
The following two articles will delve deeper into reasons and risks in cryptocurrency arbitrage and tips to remember before boarding the cryptocurrency arbitrage train.
