What is Crypto Arbitrage Trading and How Does It Work?

Crypto Arbitrage Trading is just like regular arbitrage. This is the process in which you buy and sell a cryptocurrency across different platforms and benefit from the price differences between them. Since every cryptocurrency exchange values different cryptocurrencies differently, this opens up amazing opportunities for cryptocurrency arbitrage around the globe.

Traders buy cryptocurrency from one exchange and sell it on another exchange whenever they find a reasonable price difference.

Keep in mind that the profit in arbitrage depends highly on the speed and volume of every trade you make. That’s why arbitrageurs need to master the skill before taking on the challenge, as there are no shortcuts in this process.

This guide article focuses on a well-explained overview of cryptocurrency arbitrage and how you can see if this trading style meets your needs. You will learn how profits are calculated in crypto arbitrage and how losses are mitigated. You will understand the risks involved in cryptocurrency arbitrage and how the risks can be minimized.

The guide will also explain the crypto arbitrage trading methods and the risks traders might face during this process. Before starting, let’s first shed some light on the definition of crypto arbitrage trading and how you can benefit from it.

What is Crypto Arbitrage Trading?

Crypto Arbitrage is the act of buying cryptocurrency from one exchange and selling it on the other. Since every crypto exchange has some difference in the price of cryptocurrencies, arbitrage traders can make small profits by making bulk and fast transactions.

For example: If the price of Bitcoin is higher on exchange X as compared to exchange Y, you can buy Bitcoin from Y and sell it to X to make an immediate profit.

An arbitrageur is always looking for price differences in the same cryptocurrency on different exchanges. Whenever they find the process difference, they buy the Bitcoin and make the transaction as soon as possible to bag their profit. The main reason for price differences on different exchanges is the difference between trading volumes and demand for a cryptocurrency at any given time.

Although cryptocurrency arbitrage is less risky, the rewards are also on the lower end. To keep making profits continuously, traders have to stay vigilant and make a proper trading strategy to avoid losses in the long run.

How does Crypto Arbitrage Trading Work?

As Bitcoin keeps becoming more popular, the number of Bitcoin exchanges is also increasing rapidly. However, there is no set price for Bitcoin or any other cryptocurrency across the market. Since the prices of cryptocurrencies vary widely across different crypto exchanges, this creates multiple arbitrage opportunities for traders around the globe.

For example, if a person sees that Bitcoin costs $20,000 on one exchange and sells for $20,200 on another exchange, they can quickly buy one Bitcoin from exchange 1 for $20,000 and sell it for $20,200 on exchange 2. This will make them $200. After spotting the opportunity, all our users have to do buying and sell the cryptocurrency rapidly to earn a profit in terms of the price difference.

Triangular arbitrage can also let users benefit from the price differences across different exchanges and make small profits by trading quickly. Triangular arbitrage includes three crypto exchanges.

Triangular Arbitrage

This complex trading method involves trading three cryptocurrencies across exchanges and then quickly changing those cryptocurrencies into the desired crypto to make a quick profit.

Hows do Cryptocurrency Prices Work?

By taking a brief look at cryptocurrency arbitrage and a few examples of arbitrage trades, you might be wondering about the price differences and how the price of a cryptocurrency is determined on different exchanges.

Critiques mention that Bitcoin and many other cryptocurrencies are just hype and aren’t backed by anything. On the other hand, supporters of Bitcoin believe in it and its value as it provides users with a transparent and immutable way of making P2P transactions without involving any third party.

The price of every cryptocurrency depends entirely on its demand and supply. Every cryptocurrency and fiat currency retains its value for only as long as people are willing to buy and sell it in the market.

Crypto exchanges never control the price of any cryptocurrency. Rather, they only list different cryptocurrencies, and the demand and supply for those cryptocurrencies automatically determine their value. Whenever the trading volume of a cryptocurrency increases on big exchanges, the price per cryptocurrency unit decreases as more investment is attracted to it.

For example, an average Bitcoin transaction takes around 10 minutes to complete. During this time, there is always a risk of decreased cryptocurrency value, and this can eat away the profit from an arbitrage trader.

Moreover, arbitrage trading is very risky, and the market can undergo rapid price fluctuations, especially in the case of cryptocurrencies. So, to become successful in cryptocurrency arbitrage, traders have to learn proper techniques and remain patient throughout the process.

Crypto Arbitrage Trading Methods

When it comes to the execution of arbitrage trades, there are a total of 4 different methods traders can choose from.

Let’s take a look at some of the most popular crypto arbitrage trading methods.

Triangular Arbitrage

Triangular Arbitrage is different from other types of arbitrage in the way that it requires the addition of another factor to the arbitrage equation.

Whenever an arbitrageur sees price differences between three different crypto assets across multiple exchanges, they can buy and sell these assets in a triangular manner to benefit from the price difference.

A majority of cryptocurrency exchanges offer multiple currency trading pairs. You can explore different pairs like BTC/USDT and ETH/ BTC to execute trades and convert one cryptocurrency into another. Arbitrageurs do some quick maths and find triangular arbitrage opportunities to execute the trades and bag their profits quickly.

Automated Arbitrage

The reaction speed of us humans is very slow, especially when compared to automated software and machines. Cryptocurrency prices are very volatile, and the market can undergo huge price changes in less than a second.

Even if an arbitrageur succeeds in finding an arbitrage opportunity, there is no guarantee that the price will remain the same when you finally make the transaction, and there’s no guarantee that you will always make a profit from crypto arbitrage. This is why automated arbitrage trading was introduced.

Crypto arbitrage bits are developed by various companies, and they help arbitrageurs in executing arbitrage trades and making profits in a fully automated way. This is also a perfect way to eliminate any human errors and timing issues when finding and placing arbitrage trades quickly. There are lots of crypto arbitrage bots available in the market.

Simple Arbitrage

This is a precise crypto trading strategy to make small yet long-term profits. Traders can easily find arbitrage opportunities across different crypto exchanges, cell the targeted cryptocurrency for less money on one exchange, and sell it for a higher price on another exchange to make a profit.

Since cryptocurrency exchanges are unregulated and immutable, traders can make as many transactions as they can to make maximum profits from crypto arbitrage. Simple arbitrage focuses on making quick yet small profits from bulk transactions made within a short period.

Statistical Arbitrage

This type of arbitrage depends on manually done statistical calculations, which lead to the traders placing multiple arbitrage trades. Statistical Arbitrage depends heavily on past statistical calculations. However, history never exactly repeats itself.

DeFi Arbitrage

The key selling point of the DeFi industry is that it’s immutable and doesn’t require the involvement of any third party to mark the trades as complete. Decentralized Finance works by using smart contracts and stablecoins like USDT to help transfer value from one trader to the other.

DeFi exchanges and platforms rely on their coding. This has also made lots of arbitrage opportunities available in the field of DeFi.

For example, traders who want to stake their stablecoins on DeFi platforms keep analyzing the yields on different platforms and quickly transfer their staked assets to the platforms providing more yield to earn a profit.

There’s another DeFi Arbitrage technique used by traders, but the technique only works with decentralized crypto exchanges. Just like simple arbitrage, traders can buy and sell crypto assets across multiple DEXs to earn profits from the price differences.

However, arbitrageurs have to pay gas fees when making transactions and to transfer their profits. Gas fees also keep changing with time. So, the profit traders can make from DeFi Arbitrage can keep varying over time.

Is Crypto Arbitrage Profitable?

If you’ve just started crypto spot or futures trading, the chances of you making any profit from your early trades are next to none. However, if you have the right skills and tools for a competitive and reliable market analysis before placing trades, you can benefit immensely from crypto arbitrage.

If you’re a trader and can spot the difference in the prices of the same cryptocurrency on two or more crypto exchanges, you can focus on doing arbitrage trading to keep your trades profitable. Keep in mind that crypto arbitrage profits depend heavily on your spread and how quickly you place trades to take the maximum profit.

With larger spreads, arbitrageurs can make more profit from every trade. An important factor you should keep in mind is the trading fees. For example, if your crypto arbitrage profits margin is 1%, and the fee per transaction is 0.5%, you’ll make a net profit of 0.5% per trade. You can keep tracking the changes in trading fees on every exchange and move to the one providing lower transaction fees.

Although crypto arbitrage works perfectly, it requires arbitrageurs to execute trades quickly. This is why making a reasonable profit from crypto arbitrage trading has become difficult these days. Crypto exchanges are now working to improve their technologies and eliminate any price differences in cryptocurrencies throughout the crypto market.

A great way to eliminate speed-related issues is to start using automated crypto arbitrage trading bots. However, these bots are automated and provide less flexibility when it comes to setting them according to your crypto trading requirements.

Crypto Arbitrage: Calculating Profit and Loss

While crypto arbitrage surely depends on the price difference of a cryptocurrency across multiple crypto exchanges, it is not the only factor you have to consider to calculate your profit and loss in crypto arbitrage trading.

There are lots of factors you have to take into consideration when calculating your profit and loss from arbitrage.

For example, the transaction fees are different on every cryptocurrency exchange. That is why you will have to consider the transaction fees before you can buy a cryptocurrency and sell it on the target crypto exchange to make a profit.

For example, whenever you buy and sell cryptocurrency across multiple crypto exchanges, you have to pay the maker and taker fees at both ends. Usually, this fee is around 0.02% of the whole transaction amount.

The fee structure is explained by every crypto exchange, and you must consider taking a look at the maker and taker before benefiting from crypto arbitrage opportunities.

While most crypto exchanges do not charge their users any money for deposits, you should still check with your crypto exchange to make sure. Deposits are free of cost, and there is no hidden fee included.

The withdrawal fees, on the other hand, are charged by almost every cryptocurrency exchange. Rather than the platform, the withdrawal fees always depend on the asset you are trying to withdraw.

To confirm the transaction, final withdrawal fees might also be charged by your crypto exchange.

Cryptocurrency exchanges charge fees to maintain themselves in the long run. However, we cannot deny that the fees charged by these platforms eat away at the arbitrage profits of traders.

Arbitrageurs have developed some workarounds to dodge the fees and make them minimal in many cases. Whenever you find an arbitrage opportunity on multiple exchanges, do some quick research and see which exchange charges the least amount of fees.

If you can avoid converting your crypto assets into fiat currency and keep it as it is, many crypto exchanges won’t charge you any withdrawal fees.

If two cryptocurrencies match with one another, you can get the order processed immediately. There will be no time lag or fees involved in the process.

Credit card companies charge the highest amount of fees for crypto deposits. You should therefore use Wire or bank transfers.

Fees are not the only factor that can affect your final profit from crypto arbitrage. There are lots of other factors which can play their part as well.

Since the cryptocurrency market is highly volatile, there is always a chance of rapid price fluctuations within a short time. These fluctuations can take place even before you can execute your arbitrage trades. This can easily eat away your profit within seconds.

Countries have now started to recognize cryptocurrency as an asset, and the profit you make from crypto arbitrage is also taxable.

For example, if you have Bitcoin in the United States or Australia, it will be considered property, and you will have to pay the capital gains tax regularly. Germany tops the list with over 45% income tax applied to cryptocurrencies that are held by the buyer for less than a year.

Depending on the country you are living in, you might be required to pay taxes from anywhere between 5% to 15%. This is the main reason why many people think twice before starting crypto arbitrage trading.

Is It Legal?

Yes, cryptocurrency arbitrage is perfectly legal, as this involves exploiting the price discrepancies across multiple crypto exchanges. This happens because of the unique nature of every crypto exchange.

One exchange can indirectly benefit another exchange by tightening its rules. In the end, it all depends on how you play with the market and how quickly you can act to back the profit after finding an arbitrage opportunity.

However, in countries where cryptocurrency trading is still banned, crypto arbitrage might also be considered illegal. So, you should also check with your local laws before starting crypto arbitrage. This will help you get an idea about the taxes you have to pay and about any issues you might encounter during the trading process.

Moreover, the crypto market has always been volatile and will continue to function like this forever. This is what makes it such a lucrative market for arbitrageurs and traders who are looking to make a quick buck without spending a lot of time on each trade.

Market inefficiency is what gives birth to cryptocurrency arbitrage opportunities. This pushes arbitrageurs to start exploiting the market. The increased volume of trades because of crypto arbitrage stabilizes the market as well.

Final Words

Crypto Arbitrage is a perfect way of making a quick buck because of the price differences across the crypto market. If you can make and execute your arbitrage trades with the proper technique, you can turn them into a long-term income source as well.

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