What Is Cryptocurrency Arbitrage And How To Benefit From It?

In this day and age, opportunities related to arbitrage are becoming quite prevalent within the cryptocurrency industry. This provides traders with a lucrative method of potentially maximising their profits. However, it is nevertheless extremely important to understand that arbitrage, specifically crypto arbitrage, has many pitfalls as well as upsides. This is true with any trading strategy, and it is thus important to know all the ins and outs before you get involved, and so in this article, the most intelligent methods of getting involved with crypto arbitrage shall be discussed.
However, before that, the idea of arbitrage in a more or less general sense shall be talked about first. To that end, please make sure to read on to the very end in order to get a good idea of everything that will be discussed in this crypto arbitrage article and how you can stand to benefit from getting involved in this increasingly popular trading strategy.
Arbitrage
Arbitrage may be understood as the act wherein an individual will purchase a security in any given market and then sell it in another market. The sale will take place at a higher price, which needs to be done in order to have the individual in question be able to profit off of the difference in price. In the past, numerous traders worldwide have routinely gotten involved in arbitrage, and this was a viable trading method long before cryptocurrencies ever even existed. In other words, arbitrage has existed long before the cryptocurrency market has.
Moreover, at its most basic and standard level, we can understand arbitrage to mean that any given trader may be able to capitalize on the non-uniformity pertaining to the price rise of any given asset, which would take place across multiple markets. Basically, if the price of any given asset tends to be lower in one place, then the trader would then subsequently sell the asset via another exchange, albeit at a higher price.
Crypto arbitrage
Regarding the cryptocurrency market, in particular, the notoriously volatile and often unpredictable cryptocurrency market and exchange sector mean that those traders who invest in cryptocurrency assets are essentially taking a great risk in exchange for potentially higher profits. Crypto arbitrage would then function in a similar way to that of normal arbitrage, in the sense that the trader would try and buy a cryptocurrency from one place at a lower price and then try to sell that digital asset elsewhere at a higher price, thereby earning a profit.
For instance, if one cryptocurrency exchange sells Bitcoin (BTC) for a set price and then another cryptocurrency exchange will be selling it for a slightly higher price, then the arbitrage can buy the digital asset on the first cryptocurrency exchange, after which he would transfer the BTC to the other exchange. At this point, the trader would then sell the BTC at a slightly increased rate. As a result of doing all this, the trader would then have earned a profit since he would have sold the BTC at a higher price than what he would have bought it for.
As such, since there are more than 300 spot market exchanges which all sell cryptocurrency assets such as BTC and ETH at relatively different prices, this would mean that crypto arbitrage opportunities may indeed be limitless. This mindset would hence explain why traders from all over the world are actively looking towards finding viable methods such as those related to crypto arbitrage in order to make a profit by capitalising on split-second price differentials that take place across many different exchanges.
One thing to keep in mind, though, is that the profits generated via such trading activities will primarily rely upon the speed with which any given arbitrageur would be able to successfully capitalize on the aforementioned uncorrelated pricing pertaining to a given asset. Therefore, in most cases, any given price difference which would occur across multiple exchanges would exist just for a small amount of time, usually for little more than a fleeting moment.
As a result, the more that the arbitrageurs would try to capitalize on the spread which will occur between two different exchanges, the much higher the probability will be of price convergence. Simply put, traders would then have to take advantage of the opportunities pertaining to crypto arbitrage which will present themselves ahead of the other traders. Otherwise, there would also be the risk of potentially incurring substantial losses.
It is also important to keep in mind that cryptocurrencies can be much more volatile and unpredictable as compared to other tradable asset types. The rewards may indeed be greater with these digital assets. However, so will the risks associated with this kind of trading, so caution is advised.
Legality
Despite the success that the cryptocurrency industry has had over the course of the last decade, one of the biggest challenges that the sector has to continuously go through even today is centred on the legality of this new booming industry. Many have been able to earn substantial profits from cryptocurrencies on a regular basis. However, this has led to numerous governmental and regulatory authorities questioning the legal status of cryptocurrencies which includes the digital assets themselves as well as many different cryptocurrency exchanges.
However, some of the more notable exchanges, such as that of Binance, have made it known that it would be best to work alongside the regulators in order to further legitimise cryptocurrencies. In any case, you will be happy to know that the crypto arbitrage process, which involves capitalising on different market inefficiencies, is, in fact, totally legal. Furthermore, it could even be argued that crypto arbitrage is a vital competent pertaining to the overall uniform uniformity regarding the cryptocurrency market.
You see, whenever price differentials take place across different cryptocurrency exchanges, the overall trading activity will ultimately result in the prices of any given digital asset across different exchanges converging. As such, you can thus get involved with crypto arbitrage safely, and you will never have to worry about the process from a legal standpoint either, which makes this already appealing trading strategy even more attractive.
Also, as mentioned earlier, crypto arbitrage is just one type of arbitrage that many traders tend to get involved in. As such, there are many different types of crypto arbitrage activities.
Different crypto arbitrage types
For the purposes of this article, those crypto arbitrage activities which are the most popular amongst various cryptocurrency traders shall be talked about in detail. This list is in no way exhaustive, but it does cover the primary methods through which many cryptocurrency traders and enthusiasts traditionally like to take part in crypto arbitrage endeavours.
Firstly, there is the ‘Deterministic Arbitrage’. Deterministic arbitrage may be understood as the simplest form of crypto arbitrage activity. Essentially, it involves traders buying and selling simultaneously regarding any given digital asset across two different exchanges. This is done in such a way wherein the traders would hence be actively trying to profit from the different market inefficiencies which would take place.
Simply put, this kind of crypto arbitrage activity would involve a trader attempting to identify the arbitrage opportunity wherein he would try to buy and sell a cryptocurrency asset via two specific exchanges. He would thus buy the asset on the exchange, which has the lower price and afterwards, he would try to sell it on the exchange, which has the higher price. This is again a textbook method of arbitrage that is not really complicated, and anyone can take part in it relatively quite easily.
After this, there is the ‘Triangular Arbitrage’. Here, opportunities are also presented for traders to profit from the inefficiencies and uncorrelated pricing regarding three different cryptocurrency pairs instead of two. Triangular arbitrage is particularly useful whenever any given cryptocurrency asset may be momentarily under-priced on a given platform. For instance, a trader would first make a purchase of BTC for ETH. Afterwards, he would then convert the ETH to ADA and then trade the ADA back to BTC.
In other words, this process would therefore include the moving of funds via the initial pair, the second pair, and then the final third pair, which would all then culminate with the aim of having more BTC in the end. It might seem a bit complicated, but many traders all over the world actively use triangular arbitrage in order to get involved with more cryptocurrency pairs in an effective, profitable and easy manner.
The next type is that of ‘Decentralised Arbitrage’. Here, traders would try to look for opportunities In order to execute arbitrage trades via various decentralised exchanges. Some of the more notable decentralised exchanges in the world today include Uniswap and Curve, for instance, among others. Moreover, as it is with different centralised cryptocurrency exchanges, the activities associated with decentralised arbitrage will ultimately result in the much-desired price uniformity across different exchanges. Decentralised arbitrage is hence particularly useful for the cryptocurrency industry.
The last type which shall be discussed in this article is that of ‘Statistical Arbitrage’. This type includes the usage of quantitative data models as well different bots in order to successfully profit from various arbitrage opportunities at scale. As the entire process would thus be completely automated, this kind of crypto arbitrage would hence provide traders with the ability to potentially execute hundreds of different trades in just a few minutes. By doing so, the traders in question would be able to gain immense profits. Bot trading is also becoming increasingly popular for traders in general.
Optimising your strategy
At this point in the article, you might be thinking to yourself that crypto arbitrage can be incredibly profitable, and you should just start getting involved with it immediately. However, it is nonetheless very important to slow down a little bit and truly understand everything associated with this trading method, in addition to knowing how to come up with an optimal strategy that you can utilise on a regular basis.
You see, whenever someone gets involved with crypto arbitrage, the very first thing that the trader in question should always try and remember is that while getting involved with such a trading strategy can understandably be quite profitable, crypto arbitrage carries a bit more risk simply due to volatile and unpredictable nature of the cryptocurrency industry and market.
It would therefore be a very good idea and wise strategy to do what is necessary in order to successfully optimise the speed regarding your individual trades prior to the window of opportunity, which would be presented to you at different intervals so that you can make a profit before it is too late. It is thus possible to optimise your speed by sticking to different high liquidity exchanges, which have the ability to match as well as execute your orders instantaneously. By contrast, the trades on different low volume exchanges might end up taking several minutes prior to being matched successfully.
By this point, however, because the process took longer on these exchanges, the arbitrage opportunity might have already expired, and you would have missed out. Always remember that trading, especially cryptocurrency trading, is fast-acting, and so you would also need to act quickly in order to be able to earn a sizable profit.
Using a crypto arbitrage bot should also be mentioned, as you will additionally have the chance of utilising bots that are created in order to successfully optimise as well as automate the process of crypto arbitrage trading. These tools are usually used in tandem with market inefficiencies as well as trackers and are thus recommended for all types of crypto arbitrage activities.
Put simply, a crypto arbitrage bot may be understood as a kind of computer programme which has the ability to compare and contrast different prices across multiple exchanges, which would culminate in making automated trades for you in order to successfully take advantage of the various price discrepancies.
Furthermore, if you want to transfer funds between different exchanges, then it is important that you make sure that you only stick to those cryptocurrency assets which offer high transaction speeds. As such, it is not advisable for traders to try and transfer BTC from any given exchange to another one, particularly during a period of having high network congestion, as this may result in substantial losses.
What to look out for
Lastly, before you can go about getting involved with crypto arbitrage, it is crucial to look out for a few things when you are doing so. Firstly, there are the transaction fees. Presumably, you will not want to bear the overhead costs pertaining to the execution of various trades and transfers, which could eat a sizable portion of your profits. In order to successfully mitigate this, you can hence deposit sufficient holdings pertaining to various cryptocurrency assets across multiple exchanges simultaneously.
After this, you can reshuffle your respective portfolio whenever you want so that you can take advantage of a potential crypto arbitrage opportunity in such a manner that will enable you to act seamlessly and effortlessly. It is also advised to conduct your activities in such a way that you will be able to bypass any withdrawal as well as deposit fees which will have the additional benefit of allowing you to save the time it would normally take in order to process the different exchange transactions.
In this way, the only thing which you would really need to be worried about is the different taker as well as maker fees, which are usually rather low regarding high volume traders. Please note that crypto arbitragers must usually execute big trades so that they are able to create sizable profits from any given arbitrage opportunity.
Furthermore, there is also the risk associated with the usage of hot wallets that you need to know about. Getting involved with crypto arbitrage, in particular, makes you vulnerable to increased risks simply because these trades are normally required to hold cryptocurrency assets in certain hot wallets which are provided by the various corresponding cryptocurrency exchanges. This would, however, mean that the wallet is always connected to the Internet, and the traders are therefore prone to more risks.
It is hence highly recommended that you try and limit your activities to highly secure as well as reputable exchanges only as much as you possibly can.
Final Thoughts
If you’ve managed to read this far, then you will now know that crypto arbitrage has become immensely popular simply due to the fact that the cryptocurrency industry has also increased in both usage as well as popularity over the last decade. With that in mind, if you are hence able to keep to the abovementioned practices and measures, then there is no logical reason as to why you should not be able to take advantage of crypto arbitrage opportunities which are plentiful in this day and age within the cryptocurrency market.
Lastly, it is always recommended that not only should you conduct your own research prior to making any kind of investment in cryptocurrencies, but you should also keep an eye on your budget as well as overall risk appetite so that you do not end up investing more than you could possibly afford to lose.
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