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Everything You Need To Know About Arbitrage Trading Crypto

Michiel Mulders
June 6, 2020

Arbitrage trading isn’t a newly coined term. The principle of arbitrage trading works by buying and selling the same asset at a price difference. This price difference should be positive in order to make a profit.

In other words, arbitrage trading is about finding opportunities across the market to exploit price differences between similar financial assets. For a trader, this is a risk-free trade although you are still exposed to price volatility of the asset you’re holding.

This article will teach you about the following aspects of arbitrage trading crypto:

  • What is arbitrage trading?
  • Which crypto arbitrage trading strategies exist?
  • How to start with arbitrage trading cryptocurrencies?
  • What are the risks of arbitrage trading crypto? 

How does arbitrage trading crypto work?

For arbitrage trading crypto to work, you need to have active trading accounts with at least two crypto exchanges. The more the better as you can find more arbitrage opportunities between different exchanges.

To get started, you need to determine an asset you want to find arbitrage opportunities for. To keep things simple, let’s take Bitcoin as an example. The starting point of a crypto arbitrage strategy is making sure you have available Bitcoin on one of the exchanges and fiat money or stablecoins on the other exchange. 

Now, this setup is in place, we can start looking for price differences. For example, the price of Bitcoin at exchange B is 2% lower than the price at exchange A. To profit from this difference, we decide to simultaneously execute the following two orders:

  • Sell 1 Bitcoin at exchange A
  • Buy 1 Bitcoin at exchange B

This double trade allowed us to sell our Bitcoin at a higher price at exchange A and buyback one Bitcoin at a 2% lower price. To conclude, in this example we were able to make a 2% profit by trading across different exchanges.

However, do not forget to incorporate the trading fee for both exchanges when calculating the price difference. As you are executing two trades, you are paying twice for trading fees. Otherwise, you’ll end up with a lower balance then where you got started. 

Next, which crypto arbitrage trading strategies exist?

Which crypto arbitrage trading strategies exist?

Many advanced arbitrage trading strategies exist. The two most common and applicable strategies for the crypto industry are:

  • Triangular arbitrage
  • Rate arbitrage

What is triangular arbitrage?

Triangular arbitrage is a variant to traditional arbitrage where you look for price opportunities for a single asset. Triangular arbitrage focuses on finding arbitrage opportunities between three different assets on a single exchange (or across multiple exchanges to make things more complex). 

Triangular arbitrage opens up many more possibilities as exchanges often have a large number of available trading pairs for assets such as Bitcoin, Ethereum, or Ripple. Some of those trading pairs are not actively used which allows for bigger price differences where we can profit from.

To give an example, assume the following chain of trading pairs:

  • BTC/XRP
  • XRP/ETH
  • ETH/BTC

First, start the chain of trades with one asset to which we will return at the end of the triangular arbitrage loop. In this case, let’s start again with Bitcoin. We want to trade Bitcoin for Ripple, Ripple for Ethereum, and lastly, Ethereum for Bitcoin again. The goal of this chain of trades is to end up with more Bitcoin than we started with by taking advantage of pricing differences between the different assets.

Again with this strategy, watch the cost of fees as you are performing multiple trades that can eat up your potential profits.

What is rate arbitrage?

Rate arbitrage happens when rate differences exist on crypto lending platforms. For example, you can borrow ETH on platform A at a variable rate of 0.50% and lend the borrowed money on platform B for 3%. This strategy rewards you with a 2.5% annual profit on your Ethereum holdings. 

However, watch out when using this strategy. This is a riskier strategy as you are subject to loan repayments and the volatility of the underlying asset that covers the loan.

How to get started with arbitrage trading crypto?

Manually looking for crypto arbitrage opportunities is possible but not recommended. It’s not a very scalable approach to monitor the markets 24/7 to find possible opportunities. 

Furthermore, technological advancements have made it possible for regular users to benefit from trading bots that automate the arbitrage trading process. Chances are high that you will be outsmarted by arbitrage trading bots which are 100 times faster than humans. 

Therefore, seek out for crypto trading bots that offer arbitrage trading functionality. To give an example, Cryptohopper is a well-known trading bot that offers plenty of arbitrage trading possibilities. However, as many traders use the same bot, profits will be rather small.

Lastly, you can develop your own trading bot if you have the required technical skills. Shrimpy.io is an example of a crypto trading API that allows you to create custom arbitrage bots. They offer up to 1,000 different markets across 16 different exchanges.

What’s the risk of arbitrage trading?

In essence, there’s no risk to arbitrage trading crypto or triangular arbitrage trading. The sole purpose of arbitrage trading is to grow the balance of the asset you’re holding. Of course, you are still exposed to the price volatility of the asset you’re holding. 

However, the big risk many users oversee is the fee you’ve to pay for each transaction. As you are doing two or even three trades, fees can eat up your potential profit. Therefore, make sure to calculate arbitrage opportunities including trading fees.

Conclusion

You might wonder if arbitrage trading crypto is a bad thing? In the end, you are profiting from market inequalities and not hurting any person financially. Therefore, it’s a great way to increase your balance in a risk-free way. 

Furthermore, the rise of arbitrage trading helped stabilize prices across exchanges. For that reason, you won’t find big price differences for popular assets such as Bitcoin, Ethereum, or Ripple which is great for crypto traders. 

Lastly, arbitrage trading is a good strategy to make small profits, however, markets have become very efficient. Don’t expect big profits as many arbitrage bots are already active on the different crypto markets. Yet, profits can be made when a project releases a new product or sends out some exciting news. These kinds of events can temporarily disrupt the efficiency of crypto markets allowing for arbitrage trading bots to jump in to equalize the markets again.

About the Author
Contributor

Michiel Mulders is a blockchain developer with a passion for the crypto space. His interests include blockchain, entrepreneurship, marketing, and carefully crafted beers. Cheers!

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