Cryptocurrency Arbitrage Trading Basics

Have you ever heard of arbitrage trading in crypto? At first, this concept might seem complicated and hard to understand, but we promise: once you get a grasp of it, it becomes much clearer. In this article, we’ll try to break it down for you step-by-step and help you decide whether this trading strategy fits your financial plans.

What Is A Crypto Arbitrage?

Crypto arbitrage is a set of financial strategies in which traders make a profit from the differences in price for the same asset across multiple exchanges. It’s not a secret that crypto exchanges usually have varying prices for the same currency due to supply, demand, trading volume, or even regional variations, and arbitrage benefits from it, playing as a low-risk and profitable trading method. Crypto arbitrage is legal in most countries, but traders still should carefully explore the local regulations.

For crypto arbitrage, you don’t have to be a professional trader and know all the difficult tech stuff and analyze every little market movement. This strategy is relatively straightforward, having both simple and more advanced variations that suit every type of investor. But beware: “low-risk strategy” such as arbitrage doesn’t mean that it’s impossible to lose money, and you can always make a profit—unfortunately, such a strategy doesn’t exist.

How Does It Work?

Let’s say Bitcoin costs $100,000 on Exchange A, but on Exchange B it costs $100,500. If you buy it on Exchange A and quickly sell it on B, you’ll make a $500 profit. We say quickly because the cryptocurrency market is very volatile and fast to change, making speed the key factor in crypto arbitrage. If you’re not fast enough, the price on Exchange B might drop lower than $100,000, and you will not only lose the profit but also lose the money you began with.

Well, obviously, the price difference of $500 is quite exaggerated. Usually it’s around $1-3 or even $0.1-0.2, fluctuating every second, which in its turn makes it an even more speed-dependent process.

Crypto Arbitrage Strategies

Now, when we’re familiar with the simple core of crypto arbitrage, it’s time to dive into different strategies that traders use based on this concept. All of them can be divided into 3 groups: cross-exchange, intra-exchange, and options trading arbitrage.

Cross-Exchange Arbitrage

It’s the most common and well-known type of arbitrage, which involves making a profit from price differences for the same currency on different exchanges. There are multiple variations of this type of arbitrage depending on the characteristics of the exchanges used.

1. Standard arbitrage: just like in our example with Bitcoin price, this strategy implies that the trader buys the asset on one exchange where the price is lower and sells it on another where the price is higher.

2. Spatial arbitrage: this type operates on geographical differences in pricing. Crypto exchanges located in different regions may have significant price variation due to factors like local demand, liquidity, or regulatory policies. Traders use these price gaps and make a profit from them.

3. Decentralized arbitrage: traders who use this tactic play on the price discrepancies between CEXs (centralized exchanges) and DEXs (decentralized exchanges). Prices for the same currency often vary on the DEXs due to differences in liquidity and market dynamics, of which traders can benefit.

Intra-Exchange Arbitrage

This type takes advantage of price differences within the same exchange. This happens when there are discrepancies in the pricing of the same cryptocurrency pair on different markets or trading pairs within a single platform. It can be done in two common ways:

1. Triangular arbitrage: traders use three different currencies or pairs on the same exchange to exploit price differences between them. For example, you might convert BTC to ETH, then ETH to USDT, and finally USDT back to BTC, profiting from the rate differences along the way.

2. Peer-to-Peer (P2P) arbitrage: traders who use this approach buy cryptocurrency from an individual seller on a P2P exchange (like Cryptomus P2P) for a lower price and then sell it on the same P2P platform to someone who’s ready to pay more for it.

Options Trading Arbitrage

This strategy refers to using price inefficiencies between the options market (where derivatives of cryptocurrencies are traded) and the underlying asset on the spot market. Here are the most used variants of this tactic:

1. Futures/spot arbitrage: traders play on price differences between the spot price of a cryptocurrency (its actual market price) and the futures price (the price agreed upon in a contract for future delivery). This strategy is often used by professional traders who can take advantage of arbitrage opportunities between the two markets, especially when there is a divergence in price due to market sentiment.

2. Funding fee arbitrage: in the futures market, exchanges typically charge a "funding fee" for holding positions overnight. This fee can sometimes be higher or lower than the cost of borrowing money or the price of the asset itself. Traders can arbitrage this difference by holding long or short positions in futures contracts and using spot trades to lock in profit from the funding fee.

3. Put-call parity arbitrage: in this case, traders use the price difference between options' call and put contracts for the same cryptocurrency. The principle of put-call parity suggests that, under normal market conditions, there should be a predictable relationship between the prices of calls and puts. When this relationship is broken (due to inefficiencies or market conditions), traders can lock in risk-free profits.

Manual Arbitrage Vs Bots

In crypto arbitrage there are two main technical approaches: manual arbitrage and using special bots. Both have pros and cons, and it's crucial to know and understand each tool fully before choosing any of them.

Manual Arbitrage

The principle of manual arbitrage is as simple as it sounds: you do all the work. You monitor exchanges, find price differences, and execute trades all by yourself. It sounds easy but actually requires a keen eye, constant attention, and quick decision-making.

Pros and cons of manual arbitrage:

• Full control: every step of the process is under your surveillance, so you can adjust your strategy on the go if market conditions change.
• There’s a freedom of choice because you can pick which arbitrage opportunity to take without being tied to pre-set algorithms and software that, in fact, can be buggy and lag during the most important part of the process.

• You need to constantly monitor price changes and act fast, which takes a lot of time and effort and might be very exhausting.
• Manual trades are almost always slower than the ones conducted by bots, leading to missed opportunities and lost benefits.
• Emotions might get in the way of your clear and steady mind, letting fear or greed take control of your decision-making.

Arbitrage Bots

Arbitrage bots are automated programs that monitor exchanges for price differences and execute trades automatically. They’re designed to quickly identify opportunities and act faster than humans, helping to secure profits without you lifting a finger.

Pros and cons of using bots:

• Speed and efficiency: bots can monitor multiple exchanges 24/7 and perform trades in milliseconds, taking advantage of price differences before they disappear.
• Once set up, bots can run autonomously, saving you time and effort, and they also never get anxious nor greedy, which helps to avoid emotional trading mistakes.

• Setting up a bot, especially a custom trading one, can be complicated and takes some technical knowledge in the field. They also require maintenance to ensure they’re working correctly.
• Some bots are expensive to use, with subscription fees or high upfront costs. If at the end of the day the bot doesn’t work as well as you hoped, you may lose invested money.
• Bots may not be able to react to extreme market conditions, as well as might malfunction or encounter a problem, which could lead to missed opportunities or even losses.

So, which is better? Just like everything in the cryptorealm, the choice of the approach depends heavily on your individual needs and skills. Go for manual arbitrage if you prefer more control, have the time to monitor markets, and want to avoid relying on automation. Choose bots if you’re looking to save time, execute trades faster, and don’t mind investing in the initial setup or maintenance costs. The decision is all yours!

Advantages And Disadvantages Of Crypto Arbitrage

For your comfort, we’ve arranged a table, describing the pros and cons of crypto arbitrage:

Advantages:

• Profit Potential: Arbitrage can yield quick profits by exploiting price differences across exchanges.
• Low Risk: Since it involves buying and selling the same asset, the risk is generally lower compared to other trading strategies.
• No Need for Market Prediction: Traders don’t need to predict market movements—just identify price differences.
• Diversification: Arbitrage allows for diversification of trading strategies without relying on market trends.
• Opportunities in Different Markets: You can take advantage of price differences across multiple exchanges or regions.

Disadvantages:

• High Competition: Many traders use bots, making opportunities harder to find and profit from.
• Fees: Exchange fees, withdrawal fees, and transaction costs can eat into profits.
• Capital Requirements: Requires significant capital to make meaningful profits, especially when transaction fees are high.
• Slow Execution: Manual arbitrage can be slow due to the need for constant monitoring of price discrepancies.
• Market Volatility: Sudden price changes or volatility can lead to missed arbitrage opportunities or unexpected losses.

How To Make Money With Crypto Arbitrage?

To make money with crypto arbitrage, you need to carefully monitor multiple exchanges, quickly capitalize on price differences, and factor in transaction fees. While the potential for profit is there, it requires attention to detail, speed, and sometimes automation to scale effectively. Here’s a step-by-step guide on how to begin making money on crypto arbitrage:

1. Understand the basics of crypto arbitrage;
2. Choose your exchanges;
3. Use arbitrage tools or monitor manually;
4. Calculate transaction fees;
5. Consider liquidity;
6. Execute the trade;
7. Repeat and scale.

By following this simple guide, you can easily dive into the crypto arbitrage and start making a profit from it. Give it a try!

Did you find this article helpful? Is the concept of crypto arbitrage clearer to you now? Did we convince you to try it out? Let us know in the comments below!