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It is a great skill to make money. However, learning to make money from money is a far more great thing that you need to learn in order to enjoy the profits generated by the cryptocurrency arbitrage. Over the years, cryptocurrency has been seen as just the passing trend, especially by those that think cryptos cannot compete with fiat currency. However, cryptocurrency has come a long way to gain much popularity all over the world. It is surprising to see Zimbabwe, an African country, has completely enabled all transactions with cryptos.
There are a lot of ways that you can utilize cryptocurrencies to make money and eventually make money from money. In this article, we will talk about one such method, crypto arbitrage and answer how to make money with crypto arbitrage. This will be an in-depth article, so grab a cup of coffee.
What Is Cryptocurrency Arbitrage?
Arbitrage is a pretty familiar concept that has been lingering around us since the stocks, foreign markets and bonds evolved. Cryptocurrency Arbitrage can be defined as buying and selling the same digital asset on various platforms to earn a profit from the difference between the listing price on both of these cryptocurrency exchanges.
For instance, if Bitcoin (BTC) is available on a platform (platform A) at a higher price and on another platform (platform B) at a lower price, then you can buy BTC from platform B and then sell it on Platform A. You can then enjoy the difference amount as your earning or profit.
These opportunities arise owing to the price difference between the platforms that is caused by the instant surge in the trading volumes or the inefficiencies within the crypto exchanges. The smaller platforms tend to abide by the prices that are set by the larger exchanges. However, this does not occur instantly. This is where the crypto arbitrage takes place.
The bigger digital currency exchanges can offer even better prices while the smaller exchanges attempt to compete with them to offer something that is similar. But these prices highly rely on the demand and supply making the smaller exchanges far more stable. Is cryptocurrency arbitrage profitable – is one of many questions that is asked often. You will get to know once you reach the end.
Types of Arbitrage In Cryptocurrency
Leveraging becomes possible as long as the cryptocurrency markets are not at all perfect. Primarily, there are two types of crypto arbitrage:
- The arbitrage between the crypto exchanges or crypto coins. This is also known as the Triangular Arbitrage.
- The arbitrage that happens within the exchanges.
The arbitrage between the two crypto exchanges is pretty popular and people generally speak of this kind of arbitrage when they are talking about crypto arbitrage. But if you are willing to conduct arbitrage within the same crypto exchange, you are required to buy two different crypto assets from the same exchange and also sell it in the same exchange when the price rises. In case any trader is looking for crypto arbitrage, then they will have to take into account all the risks and rewards associated with it.
1. Triangular Arbitrage
In finance, the normal arbitrage refers to the triangular arbitrage for three exchanges. This simply offers you to take advantage of the difference in the listing prices on the various cryptocurrencies. It involves the process of moving the funds between three or more digital assets on a single cryptocurrency exchange for capitalizing on the cost discrepancy of one or two crypto coins. For instance, a trader might choose to create a trading loop that begins with Bitcoin and also ends with Bitcoin.
The trader might also choose to exchange Bitcoin for Ether and then trade the ETH for Cardano’s ADA token. Lastly, he can convert the ADA back to BTC. In this example, it is depicted that tnbe trader had moved his funds between the three crypto trading pairs – BTC/ETH → ETH/ADA → ADA/BTC.
In case there are discrepancies in any of the prices of the crypto trading pair trio, the trader will end up with even more Bitcoin that they had at the initial phase of the trade. In this case, all the transactions are executed on a single exchange. Thus, the trader does not require to deposit or withdraw the funds across multiple exchanges.
Additionally, there are two other popular methods viz., statistical arbitrage and cross-border arbitrage.
2. Cross-Exchange/Cross-Border Arbitrage
The cross-border arbitrage or cross-exchange arbitrage can be defined as the kind of arbitrage that includes two exchanges in action that are located in different countries. You can as well have the cross-border arbitrage in the form of the triangular arbitrage that consists of the three exchanges providing differences in the pricing.
3. Statistical Arbitrage
This combines the statistical, economic as well as the computational techniques for executing the arbitrage trades at scale. The traders that make use of this method often depend on the mathematical models and crypto trading bots for executing high frequency arbitrage trades and maximize the profits. These bots are automated trading mechanisms that execute a relatively high volume of the trades at the recorded time depending on the pre-defined trading strategies.
On the contrary to all the other kinds of arbitrage strategies, statistical arbitrage is quite challenging to pull off owing to the fact that it involves mathematical modeling. It is quite riskier as in a cryptocurrency market, things can change in just a blink.
4. Spatial Arbitrage
This is a different form of the cross-exchange cryptocurrency arbitrage trading. The sole difference is that the crypto exchanges are located in different regions. In this type, you could go ahead and capitalize on the difference in the demand and supply of BTC in South Korea and America making use of the spatial arbitrage method.
5. Spatial Arbitrage Without Transferring
Some of the traders strive to avoid the risks of the transfer costs as well as times that the spatial arbitrage possesses. For instance, in a hypothetical case, they might go long Bitcoin on one of the exchanges and short on the other as well as wait till the prices on the two exchanges meet. This permits them to avoid the transfer of coins and tokens from one platform to another although the trading fees might still be applicable.
6. Decentralized Arbitrage
This variant of arbitrage is quite common on the decentralized exchanges or the Automated Market makers (AMMs) that finds out the price of the crypto trading pairs with the aid of the automated and the decentralized programs known as the smart contracts.
If the price of the cryptocurrency trading pairs are significantly different on the centralized exchanges from their spot prices, then the arbitrage traders might plunge and execute the cross-exchange trades with a centralized and a decentralized exchange.
How Does Crypto Arbitrage Work?
Here is the answer to “how does cryptocurrency arbitrage work”. As we have already discussed in the previous section, arbitrage can be caused by a couple of reasons or the market factors. Amongst the several factors, one of the most important factors is the variance in the trading volumes between the cryptocurrency exchanges. In the larger exchanges, the crypto trading volumes might be much higher leading to the lower prices. On the contrary, in the other exchanges where there is minimal trading volume, the price of the digital currencies might be higher.
The big players in cryptocurrency trading are basically the hedge funds and the whales. Whales are those individuals that have been able to acquire a huge amount of cryptocurrency for themselves that is worth over millions. They were the early adopters of crypto, who benefitted on a large scale during the cryptocurrency boom period before the prices nosedipped. They both possessed experience and resources that are needed to be able to carry out a cryptocurrency trading arbitrage, creating even larger profits from it owing to the pool of funds that are available to them.
On the other hand, the hedge funds are a single entity that extracts funds from a pool of investors, performs the trade on their behalf and then distributes the profits amongst the involved investors. Usually, the hedge fund managers perform this, who are considered to be extremely experienced. These managers possess a high level of the analytical skills needed to make better and more profitable trading decisions. Additionally, they also have strategies that are required to make such bold and risky moves.
For all the smaller investors, who are neither in the category or are the whales or possess the minimum funds that are required for the hedge funds, can still participate in the crypto trading arbitrage and thereby make some reasonable profit from this new avenue. However, with the lesser funds this highly risky trading cryptocurrency arbitrage strategy might both wipe out their profits as well as generate the trading losses in case the cryptocurrency market gets too volatile in their trading period.
Even the geography or the geo-location plays a major role in the cryptocurrency arbitrage as it might be harder or easier to sell during the variable times of the day. If you want to be successful at this, you would have to look out for an opportunity or crypto arbitrage signals. As soon as you notice an opportunity, you would be required to execute it quickly. You can also go ahead and document in your order book as to how much you will be making by buying and selling your digital currencies on different platforms and then make a decision accordingly.
It consumes around 15-20 minutes for the major crypto coins for confirming the transaction. If within the time frame, the market price drops, then you might run a risk to generate less arbitrage. Simultaneously, it can be stated that crypto arbitrage is quite rare as the market is much more volatile as compared to the normal financial market. In such a case, you might need to wait for a couple of days in order to execute a perfect arbitrage. This is considered as the single side trade where you purchase cryptocurrency and you cannot sell it from an arbitrage.
Finally, after you perform the cryptocurrency arbitrage, you need to ensure that you do not mess up the things. Make sure you double check your analysis of the buying and selling of the listings on the exchanges. Additionally, make sure to have a closer look at the crypto trading volumes.
In this regard, you might be able to find programs or a cryptocurrency arbitrage bot that perform the arbitrage work for you. However, they might not be that effective as there are a plethora of risks that you need to consider, one of which is security. In order to perform the arbitrage of cryptocurrencies, you are also required or is mandatory to open up accounts on the various cryptocurrency exchanges. And by doing this, you are actually making yourself vulnerable to the security risk as some of the platforms might get hacked or the exchange might steal your assets if they are not that reputable.
What Are The Advantages & Disadvantages Of Cryptocurrency Arbitrage?
Similar to most of the things, Crypto Arbitrage too has its own pros and cons that we have discussed here. Consider these positives and negatives before just diving straight away. Check if you are ready to take the crypto trading risk and enjoy the profit or loss depending on the situation.
Pros
Rapid Profit
You are able to perform cryptocurrency arbitrage as early as the transactions get over that might be within an hour or even lesser. This is much quicker than the traditional trading where you purchase and hold the crypto coins to sell at a later date.
Plethora Of Opportunities
There are several cryptocurrency exchanges these days in the market. With so many options, there exists a wide range of opportunities for cryptocurrency arbitrage. Coindesk states that there exists over 391 crypto exchanges across the countries globally.
Developing Crypto Market
This fact is not unknown that digital currencies are yet to be accepted widely by the public and thus the crypto market is yet in the initial stages of its development. Owing to this, there is quite a bit of disjointing, irregularity and lack of information transfer between the crypto exchanges. There are also a lesser number of the crypto traders and this less competition in the market. This leads to the potential price differentials.
Cryptocurrency Volatility
Even though Bitcoin (BTC), the first cryptocurrency, was launched back in 2009 by Satoshi Nakamoto, it is one of the most volatile cryptocurrencies in the market. This is owing to the changes in the supply and demand in addition to the fact that the coin is highly decentralized. As the cryptocurrencies are so volatile, there can be immense price changes between the exchanges. This provides an opportunity for arbitrage.
Cons
KYC Restrictions
You are required to adhere to the KYC regulations of an exchange if you want to trade on that cryptocurrency exchange. There are times you have to hold a bank account in the same country from where the cryptocurrency exchange belongs or you might be required to link your bank account as well as verify your identity. This might consume up to 24 hours for verifying your account through the KYC before you can attempt to trade.
Crypto Storage
As you are required to access multiple exchanges for conducting cryptocurrency arbitrage, you might be required to store your coins in all of the platforms. As your crypto coins are held in the online accounts, they are prone to be hacked. Some of the smaller known businesses also tend to steal the coins from their customers. Thus, you would need to be aware of this risk before you begin signing up for crypto trading on the platforms that are less established.
Fees
The cryptocurrency exchanges do not allow you to deposit, withdraw or trade for free. Thus, they will charge a definite percentage of money as their fees. Thus, you would need to include the fees while calculating the profit that is made from the arbitrage.
Taxes
In the United States, where the crypto adoption in recent years have skyrocketed, the Internal Revenue Service (IRS) has curated a tax guide that categorizes cryptocurrencies as property. The Securities and Exchange Commission (SEC), on the contrary has referred to cryptocurrencies as the form of security while the Commodity Futures Trading Commission has regarded them as a form of commodity.
Thus, the IRS treats the gains from cryptocurrency the same way the gains from selling property is treated. Keeping that in mind, the investors have to account for any capital gains taxes on their Federal Income Tax Return, but might also be able to take deductions depending on any losses.
Large Trades Is Equal To Better Profit
The profits you earn from the cryptocurrency arbitrage might be relatively smaller after all of the processing delays as well as the applied fees. In order to make huge profits from the cryptocurrency exchange through crypto arbitrage, you would be required to increase the trading volume.
Withdrawal Limits
On placing larger trades, you need to fix this in your mind that the exchanges bear specific withdrawal limits. Thus, you might not be able to withdraw the cryptocurrency balance from your wallet on the same date of transaction and crypto arbitrage receipt.
Timing
Each of the cryptocurrency transactions might take up to 10 minutes or more to be completed as well as verified by the miners. During this period, the crypto market might move against you leading to loss of the potential arbitrage profit. There could be many cases where the trader has not yet received any of the profits as the market has collapsed and that the profit had turned into loss.
In some of the other cases, you might have purchased crypto assets from one exchange but the market went against you and you are not able to sell the coins on the other exchange.
Transaction Speed
As the trading volumes surge on the global cryptocurrency markets, the transactions consume a lot of time to be processed and verified. This is a major issue when you are looking forward to transferring your funds rapidly. The BTC transactions take up longer to be processed as compared to Ethereum (ETH) transactions.
Competition
There might be more traders who are looking forward to cryptocurrency arbitrage and this might lead to changes in the trading volumes on the various crypto exchanges. This might also reduce the arbitrage opportunities for the others.
Pros | Cons |
Can make profit in an hour or less after transaction. | Crypto arbitrage is done through crypto exchanges that might have strict KYC policies and verification processes consuming a lot of time. |
Plethora of opportunities to arbitrage crypto with the innumerable number of cryptocurrency exchange platforms. | Cryptocurrencies are stored in online wallets/accounts in the crypto exchanges making them vulnerable to hacking and getting stolen/lost. |
Developing phase of the crypto market owing to less public acceptance gives rise to higher price differentials. | Crypto transactions on the exchanges are chargeable and you need to calculate the amount you send to these exchanges from the arbitrage you gained. |
Cryptocurrency volatility offers immense scope to gain better arbitrage. | You need to conduct larger trades to earn more profit in the arbitrage as fees and processing delays are involved. |
There are certain taxes on cryptocurrency gains in some parts of the world where crypto gains are treated as gains from the properties. | |
Crypto exchanges have specific withdrawal limits making it difficult to withdraw all your arbitrage profit on the same day. | |
Crypto transactions consume 10 minutes or more to be completed and in this period you might lose your profit if the market shifts against you. | |
Higher trading volumes on the global crypto markets increase the processing and verification time. | |
More traders lead to changes in trading volumes on different exchanges reducing the opportunities for arbitrage for others. |
Important Tips To Consider Before Trying Out Crypto Arbitrage
There are a lot of things that you need to consider. But here we have included the crucial tips that will help you while you are attempting to conduct cryptocurrency arbitrage through any cryptocurrency arbitrage website. Take a look at all of them.
New Crypto Listings
Always check out the new listings for the cryptocurrencies. If you find any cryptocurrency to be listed on a platform for the very first time, then the chances are there exists little to no demand for the cryptocurrency on the exchange.
Avoid BTC Transfers
As already stated, the Bitcoin transactions take up a lot of time to be processed and verified. Since the arbitrage of cryptocurrencies seeks to be completed as quickly as possible, the slow transaction time of Bitcoin (BTC) might disappoint your chances of a profitable trade. You can also consider several altcoins in this place such as Ethereum (ETH) that provides a much quicker transaction opportunity.
Plan Strategically
Before you directly get into arbitrage, there are a couple of factors and questions that you need to consider. It is recommended that you plan exactly how much money is going into each trade. Additionally, consider what percentage of profit you are going to make and what are the various fees that can actively reduce your profit. Making a clear strategic plan can aid in answering all of these questions and also ensure that you grab the correct arbitrage opportunity.
Continuously Monitor The Market
The arbitrage opportunities can arise at any time of the day and this seeks you to keep an eye on them on the market. There are higher chances of the differences in price during the market volatility. Thus, you need to continuously monitor the recent news and developments that might lead to such changes.
Diversify
If you are limiting your trades to just two or three exchanges, you might not notice the arbitrage opportunities or you might solely earn a small profit from any opportunities that arise. In order to earn a decent amount of profit, you need to ensure that you trade on several exchanges. This, however, also reduces the potential risk of putting all of your cryptos in one crypto basket.
Limit The Losses
As the cryptocurrency market is pretty volatile, you need to always make sure that you trade as quickly as possible or choose not to trade at all. There are times when making money risks far outweigh the rewards. Thus, it is better not to lose your coins than gamble on a crypto arbitrage opportunity. You can also check out the crypto arbitrage calculator threads under cryptocurrency arbitrage Reddit.
Implement Hedge Strategies
In order to shield yourself from the unexpected market changes, you can go ahead and make use of the hedging strategies. Hedging shields you from the potential losses and also ends up minimizing your potential profits. You can also think of hedging as an insurance policy that defends you from the imminent damages.
How To Find A Cryptocurrency Arbitrage?
When it comes to arbitrage, not all of the cryptocurrency assets or the digital assets are created equal. For example, Bitcoin is a widely traded asset resulting in the fewer BTC arbitrage opportunities. However, there are some other ways to be a part of crypto arbitrage besides investing in Bitcoin.
Method 1: The New Cryptocurrency Arbitrage Software
With a variety of different cryptocurrencies on the numerous exchanges, finding all of those opportunities is a pretty intimidating task. This is the reason most of the traders implement software applications that track the hundreds of the crypto exchanges in real time. There are an increasing number of the companies specializing in the software for automating crypto arbitrage. Some of the companies even have a tool called the cryptocurrency arbitrage scanner or screener that permits the investors to choose an automated arbitrage strategy as well as execute it across different exchanges.
Method 2: The Less Prevailing Digital Coins
The investors can also find the bigger price spreads for the same crypto digital assets amongst the less popular as well as the less-frequently traded cryptocurrency forms. Owing to their less popularity, these crypto coins tend to undergo rapid fluctuations in the price. This volatility can either be good news or bad news. However, it adds another level of risk to an existing arbitrage strategy.
Why Is Crypto Arbitrage Considered To Be A Low Risk Strategy?
You might have taken into notice that dissimilar to the day traders, the cryptocurrency arbitrage traders do not have to predict the Bitcoin’s future prices nor enter in the trades that might take hours or even days before they begin to generate the profits.
By locating the cryptocurrency arbitrage opportunities and capitalizing on them, the traders base their decision on the expectation of generating the fixed profit without inevitably analyzing the market sentiments or straightforward relying on the other predictive pricing strategies.
Additionally, depending on the resources that are available to the traders, it is feasible to enter and exit an arbitrage trade in seconds or in minutes. Keeping these in mind, we can conclude the following:
- The risk that is involved in the crypto arbitrage trading is moderately lower than the other trading strategies as generally it does not need the predictive analysis.
- The crypto arbitrage traders solely have to execute the trades that last for minutes at the maximum making the exposure to the trading risk significantly lowered.
Is Crypto Arbitrage Legal?
To answer this, we can simply say that cryptocurrency arbitrage is legal. Every crypto exchange offers its own rate for a specific cryptocurrency. It can be stated that this price is approximately the same across all the exchanges. However, sometimes, there is a divergence of around 5-10% or rarely as high as 20%.
Final Thoughts
There are multiple techniques of cryptocurrency arbitrage as well as opportunities that can benefit the individuals, whenever there exists a market inefficiency. As more of the traders indulge in crypto arbitrage, these opportunities will start to disappear in no time after they arise. This aids in the stability of the cryptocurrency market and the prices might end up being similar across exchanges. Cryptocurrency arbitrage India is as usual as in the other parts of the world.
Cryptocurrency is complicated while the arbitrage strategies might be even more complex. However, the practice is legal and possesses the potential to yield high rewards and simultaneously exposing an investor to high risk. Similar to all of the investment strategies, it is crucial for the investors to conduct their very own research while exploring the cryptocurrency arbitrage. This includes noticing the various, lesser-known cryptocurrencies as well as the available software for tracking the cryptocurrency exchanges in real-time.
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