Crypto arbitrage trading enables traders to profit from the differences in prices across various exchanges. Since cryptocurrency exchanges place different prices on them, it creates opportunities for arbitrageurs to profit from the price discrepancies.
They do this by purchasing an asset at a cheaper rate and selling it on a different exchange. Moreover, crypto arbitrage trading depends highly on the volume and speed of each trade.
So, there’s no shortcut to mastering this trading style, and you need to execute it precisely. Meanwhile, we’ll discuss the meaning of crypto arbitrage trading, how it works, and its associated benefits and risks.
In addition, we’ll be shedding some light on crypto arbitrage bots and opportunities. So, if you want to try this volatile crypto market, this article is the right fit.
Table of Contents
What is Crypto Arbitrage Trading?
If you’ve gone to two or more exchanges simultaneously, you’d have noticed that Bitcoin is valued differently on those exchanges. You’d instead see that the price on one exchange is lower or higher than the other. Hence, the phenomenon of crypto arbitrage trading.
Crypto arbitrage trading involves purchasing an asset at a lower rate on one cryptocurrency exchange and quickly selling it at a higher rate on a different exchange. The difference between the two rates is your profit.
Further, the arbitrage concept has been existing in traditional markets for years. However, crypto provides unique arbitrage trading opportunities since the market is open 24/7.
For instance, if the Bitcoin rate is higher on X exchange and lowers on Y, you can buy BTC on Y exchange and sell it quickly on X exchange. Then the price difference becomes your profit.
These price differences often result from the trading volume, which causes a shift in the demand and supply levels. Besides, crypto arbitrage trading is typically less risky and has lower returns.
However, the tricky thing about crypto arbitrage trading is to entirely understand how it works and strategically apply it for the best returns. So, let’s get to it!
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How Does Crypto Arbitrage Trading Work?
Arbitrage trading works by purchasing and selling crypto assets from one exchange to another. Typically, you buy Bitcoin on exchange A (where the price is lower) and sell on exchange B (where the price is high).
Since the cryptocurrency market is very volatile, you must make the trade very fast, almost immediately, before the prices fluctuate again. However, this may not be a challenge in some types of arbitrage trading, as we’ll discuss shortly.
The volatility is not bad since it results in abundant arbitrage trading opportunities in the crypto market.
What Are The Types of Crypto Arbitrage Trading?
There are four major crypto arbitrage types; this depends on how you do the arbitrage and the parties involved. To keep it simple, we will use Bitcoin as the crypto asset in our examples.
The following are the four main crypto arbitrage trading types:
1. Inter-Exchange Arbitrage
This type of arbitrage trading involves buying on one exchange and selling on another. Thus, it involves two exchanges.
This type of arbitrage trading is based on the real-time value of an asset. So, it’s not ideal to purchase assets on a particular exchange and transfer them to another one to sell.
So how do you get around this? Well, buy and sell the asset simultaneously. Meanwhile, you can only do this if you hold assets on both exchanges.
For example, you hold 1 BTC on exchange A and $20,000 worth of USDT on exchange B.
If BTC is worth $20,300 on exchange A but worth exactly $20,000 on exchange B, you can take advantage of this by purchasing the BTC on exchange B using your $20,000 of USDT and simultaneously selling the Bitcoin on exchange A at $20,300.
After the transaction, the $300 becomes your profit. Therefore, you won’t pay deposit and withdrawal fees for moving the asset from exchange B to A or vice versa.
2. Triangular Arbitrage
Triangular arbitrage trading is relatively simple because it’s done on a single exchange and involves three assets. For instance, you hold Bitcoin, Solana, and Ethereum.
If Solana and Ethereum are undervalued on the exchange, you can use this arbitrage opportunity to obtain more Bitcoin.
For instance, you use your Bitcoin to purchase Solana and use your Solana to purchase Ethereum. Then, use Ethereum to rebuy Bitcoin. That’s how it works!
So, you’ll get more Bitcoin than when you initially bought Solana without sending Ethereum to a different exchange and paying huge gas fees.
Since you do everything on the same exchange, no transfer, deposit, or withdrawal fees are involved.
3. Statistical Arbitrage
Here, you’ll use mathematical models to trade assets and profit from price differences. Additionally, it uses crypto arbitrage bots that can trade several assets simultaneously.
These arbitrage bots use mathematical models to predict whether a crypto trade will win or lose and trade according to the prediction.
Since bots are involved, the procedure will be automated rather than manual, so you don’t have much to do. Therefore, it becomes more convenient with a low risk of making mistakes.
4. Spatial Arbitrage
Spatial arbitrage trading takes advantage of the price differences of an asset depending on the differences in geographical locations of each exchange.
Aside from the spatial aspect, it’s very similar to inter-exchange arbitrage. One striking thing about spatial arbitrage is the differences in demand for an asset.
For instance, if you reside in a country with high demand for BTC, you can purchase from an exchange in another country where the need for Bitcoin is lower. Then sell on local exchanges in your country.
This will earn you profit since the higher demand implies that Bitcoin will be worth more. Even though this sounds like inter-exchange arbitrage, you don’t need to buy and sell depending on real-time prices.
Thus, you can purchase from one exchange and manually transfer to another to sell for profit.
Pros of Crypto Arbitrage Trading
Although crypto arbitrage trading is complex, it has good aspects. So, check them out below.
- You can do it during low and high volatility.
- Most arbitrage trades involve fewer fees.
- The trading strategy involves a low risk that requires little experience.
- You can perform transactions and earn profits immediately.
- Crypto arbitrage opportunities will be available long until the market settles.
Cons of Crypto Arbitrage Trading
As much as there are good sides to this business, you also need to know the downsides before venturing into it.
- It may need assets on two exchanges.
- Volatility leads to quick changes in price. This may be challenging in inter-exchange arbitrage.
- Since there isn’t a central bank for cryptocurrencies to account for lost funds or failed transactions, it is less secure.
- You may end up paying huge fees during the entire process.
- Some exchanges have daily withdrawal limits. So, trading large amounts may take days to reach your wallet or bank account.
- As the market grows, more traders want to profit from crypto arbitrage. This gives rise to competition.
- Crypto arbitrage requires a fast reaction since the transaction takes minutes. But even in that short time, the market may fluctuate.
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Risks of Crypto Arbitrage Trading
If you’ve ever been involved in cryptocurrency trading, you should understand that cryptocurrency trading is risky because of its high volatility.
Although specific patterns indicate that an asset’s price will go up or down, there are no guaranteed outcomes.
Crypto arbitrage trading opportunities are connected with several risks affecting final profits. An example is the fees we have already discussed.
If the price difference for the asset is not so high, your losses may be greater than your profits because of all the fees you’ll pay before the funds finally get to your wallet.
Furthermore, the KYC (Know Your Customer) processes associated with exchanges can make it difficult for a trader to perform cross-border transactions. To exchange large amounts of funds on one platform, you will provide your IDs.
Generally, centralized exchanges invest so much time and effort into security. But there can still be data leakage sometimes, and your data will get into the hands of fraudsters.
Is Crypto Arbitrage Trading Profitable?
Crypto arbitrage is profitable in some way. But since the price difference in exchanges is usually small, you’ll profit more when you invest a large sum.
For instance, let’s say you buy BTC for $25,000 on exchange A and sell it for $25,500 on exchange B. You’ve invested $25,000 to receive a $500 profit, excluding the exchange and Bitcoin fees.
Although the arbitrage trading strategy involves low risk, low risk yields lower rewards. Some people may feel that the money they can earn from crypto arbitrage is not worth the effort.
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Is Crypto Arbitrage Trading Legal?
For most parts of the world, crypto arbitrage trading is legal. The goal is to trade across Bitcoin exchanges that you can legitimately sign up for if you use an arbitrage technique incorporating various platforms.
For instance, because of the strict cryptocurrency laws, it would be challenging for South Koreans to implement most of the arbitrage trading techniques discussed here if they involve crypto exchanges from other countries.
Given that the US does not grant licenses to crypto exchanges enabling derivatives trading to the average investor, Americans also have limited access to crypto exchanges. However, individuals from countries with stricter cryptocurrency rules can frequently still carry out specific arbitrage trades.
Who Can Do Crypto Arbitrage Trading?
Crypto arbitrage is ideal for seasoned cryptocurrency traders who understand the market and have developed their trading techniques.
Trading arbitrage might require spending days at your computer monitoring the exchanges for price discrepancy opportunities, or you may automate the process using bots.
Furthermore, crypto arbitrage trading can offer more profitable opportunities with low risk than other cryptocurrency investment techniques. However, chances are that you can still lose money.
So, we suggest you understand the risks involved before deciding whether this trading strategy is suitable for you.
Arbitrage traders in the US earn an average annual income of $64,805 (as of November 30, 2022).
If, after the deadline to report, you still haven’t adequately reported your crypto gains on Form 8938, you can face additional penalties and fines. After failing to file, the IRS will notify any taxpayer who has not completed their annual reports or return.
Each time you sell crypto or trade it for another form of property, or use it as a means of payment, you’re incurring taxes. The amount you will owe depends on how long you hold your cryptocurrency and if you sold or exchanged it for a profit or a loss.
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