Cryptocurrency arbitrage – What is it? Cryptocurrencies have strong volatility, which can increase greatly from time to time. This means that in a short time the rate can change by 10% or more, due to which the rates on different exchanges may differ, opening up opportunities for crypto arbitrage.
Cryptocurrency arbitrage is an online purchase of cryptocurrency in one trading pair and sale in another in order to make a profit on the difference in rates. There are two main types of crypto arbitrage:
- Intra-exchange cryptocurrency arbitrage;
- Cross-exchange arbitrage of cryptocurrencies.
Let’s consider each of the methods in more detail.
Intra-exchange cryptocurrency arbitrage
Cryptocurrency transactions are carried out on the same exchange, but in different trading pairs, using, as a rule, an adjacent cryptocurrency. For example, exchanging ETH for BTC, BTC for USDT, and then USDT for ETH. Such opportunities are difficult for a beginner to calculate, but less money is spent on commissions, since the trader pays only for the exchange, and not for withdrawing from the crypto exchange.
Inter-exchange cryptocurrency arbitrage
The essence of this method is that the cryptocurrency is bought on one exchange and sold on another at a higher rate. It is easier to calculate such opportunities than with arbitrage within the exchange, but with a small difference between the rates, it is unprofitable to exchange cryptocurrency.
IMPORTANT! In this case, the trader also pays a commission for withdrawing from the exchange, so arbitrage between cryptocurrency exchanges requires more investments than an intra-exchange one.
Also, in case of inter-exchange arbitration, it is possible to return funds again to the first one and make another round. True, it is very difficult to do this because of the high commission for transfers, so here you need to calculate everything in detail.
Where does the difference in exchange rates come from in inter-exchange arbitration?
A significant difference in rates between exchanges occurs when trading activity is high, for example, when cryptocurrencies greatly increase or fall in price, or if large players (whales) sell cryptocurrency for a large amount on some exchange, affecting the rate. Such cases on the crypto market are not uncommon, but “arbitrage windows” open only for a limited time, which can last only a few hours.
ATTENTION! If the user during this time does not have time to exchange the cryptocurrency on the exchanges, then he bears the risks associated with the payment of the commission. He can lose for trading and withdrawing funds, and in some cases – for replenishing the balance.
Examples of arbitration
The crypto arbitrage mechanism comes down to a few simple steps that any beginner can handle. Below are the steps a trader needs to take when arbitrating cryptocurrencies.
Monitor cryptocurrency rates on different exchanges.
This can be done using any arbitration service such as CoinMarketCap, CoinGecko, or CryptoCompare monitors.
Find trading pairs in which the cryptocurrency rate differs.
It is desirable that the rate between the exchanges differs by 3% or more. In other cases, the difference between the rates may not cover the cost of the commission. But the exact number is calculated by the trader himself, based on the amount of available funds and commission costs. For example, the highest bitcoin rate at the time of this writing is on the Bithumb exchange, and the lowest on Kraken.
Let’s compare how different the course is:
$ 57,851 / $ 54,886 * 100% = 5.37%
The course differs by more than 3%. So it suits us.
Buy on the first exchange BTC for USD
Let’s say you bought 0.1 BTC for $ 54,886 on the Kraken exchange, paying 0.2% of the commission, according to the crypto exchange policy. And so, you purchased Bitcoin for $ 5,488 and paid $ 10.98 for an exchange on the exchange:
0.1 BTC – 0.2% = 0.9998 BTC
Transfer BTC to another exchange and sell coins.
On the Bithumb exchange, Bitcoin is traded at $ 57.851. But this time you pay not only for the exchange, but also for the withdrawal of funds. As a result, you paid 0.0005 BTC for withdrawal from the crypto exchange, and then another 0.1% for the second exchange:
0.9998 BTC – 0.0005 BTC – 0.1% = 0.09920007 BTC (round up to 0.0992 BTC)
You sold 0.0992 BTC at the rate of $ 57,851 and received $ 5,738. Now let’s calculate how much you made:
$ 5,738 – $ 5,488 = $ 250 or approximately 4.5% of the investment amount. Pretty good.
Earnings on arbitration between cryptocurrencies
All you need to make money on crypto-arbitrage is to correctly calculate the difference between rates and commissions for operations with crypto-currencies. It is necessary that the income from arbitration be higher than the cost of commissions. Only in this case can you make a profit.
The example shown is only an approximate income. For example, we did not take into account the price spread – the difference between the minimum price of a sell order (Ask) and the maximum price of a buy order (Bid).
Therefore, when dealing with crypto-arbitrage, it is necessary to take into account the nuances of this way of earning. We will talk about them later in the article.
The pitfalls of arbitrage on cryptocurrency exchanges
In addition to commission costs, there are a number of other factors to consider:
- The spread between cryptocurrency prices;
- Density of the order book (liquidity);
- Speed of withdrawal and replenishment on exchanges;
- Availability of replenishment / withdrawal.
The larger the cryptocurrency capitalization and the greater its liquidity, the lower, as a rule, the spread. However, during periods of increased volatility, the price spread can widen, providing more opportunities to earn money through arbitrage. But the risks for the trader will be higher, since the spread can narrow at any time.
Liquidity determines how quickly a trader can sell an asset at the current price on the exchange. The higher the liquidity, the greater the density of the order book. This means that a sharp change in the rate will require the sale of large amounts of cryptocurrency, and, therefore, there will be more time for maneuvers.
For example, on the Bithumb exchange, the amount of orders varies from 0.005 BTC to 0.19 BTC, which is quite small by the standards of the crypto market. That is, it is enough to sell only about 0.085 BTC to reduce the bitcoin rate by 0.6%.
Less popular altcoins have less liquidity, so the spread is often higher, but the risks for arbitrageurs become higher.
Withdrawal and replenishment speed
On large crypto exchanges, funds are usually withdrawn quickly – in 5-15 minutes. But it should be borne in mind that many other traders are engaged in arbitrage, and during periods of increased volatility, traders are more active in withdrawing / replenishing funds on exchanges, which affects the speed of order execution.
ADVICE! Therefore, before making transactions, you need to conduct a test crypto-arbitrage with a small amount that you are willing to risk in order to check how quickly operators on exchanges will withdraw and replenish funds on accounts.
Deposit / withdrawal availability
Sometimes, when on any of the exchanges the rate of the cryptocurrency is very different from the price on other sites, wallets can be closed on it for withdrawal and replenishment of funds.
ADVICE! Therefore, you should always check their availability before arbitrating. If the wallet is unavailable for replenishment, and you send funds to it, then they may “freeze” for a long time, or even disappear altogether.
Cryptocurrency arbitrage strategies and schemes in 2021
In this section, we present the popular crypto arbitrage schemes among traders. Each scheme can be modified, but this is only suitable for experienced traders, and for beginners it can cause difficulties.
Game on the inter-exchange spread
We described this scheme in the example of bitcoin in arbitrage: you sell cryptocurrency at a lower rate on one exchange and sell at a higher rate on another. This is the simplest scheme, but the difference between the rates for large cryptocurrencies does not often arise. Therefore, traders have to monitor for a long time before they find an arbitrage window.
This scheme is also called synthetic arbitrage. Quotes of a particular cryptocurrency may differ on the same exchange. In this case, an exchange triangle arises: traders use an intermediate pair. For example:
- First, the trader buys BTC for USDT;
- Then exchanges BTC for ETH;
- And sells ETH for USDT.
This scheme is much more difficult for beginners, so traders often use programs or arbitrage bots.
This scheme is suitable for those who store cryptocurrency on exchanges. Let’s say you hold USDT on one crypto exchange and BTC on another. Then, if on the second exchange the BTC rate rises and differs from the rate on another exchange more than the amount of the commission, then the trader can buy BTC on the first exchange at a lower rate, and sell the cryptocurrency on another at a higher price and make money on this.
This circuit may seem daunting to beginners, so it’s best to start with simpler methods and move on to more complex circuits as your skills develop.
The essence of statistical arbitrage is that traders find a correlation between the price dynamics of various cryptocurrencies. Often, during the active growth of bitcoin, the price of altcoins can fall and vice versa.
For example, when the price of BTC falls relative to the price of ETH, the trader buys bitcoin to increase the amount. And then, when the Ethereum rate falls in the ETH / BTC pair, it buys the coins back, further increasing their amount.
Selection of an exchange and selection of cryptocurrencies
The choice of exchanges for crypto-arbitrage is an important stage in the preparation of the user. Your income will depend on how quickly you can exchange cryptocurrency on exchanges. If the withdrawal from the crypto-exchange takes a long time, then the cryptocurrency rate can greatly change, and you will lose income or even incur losses. Therefore, you need to choose only trusted crypto-exchanges with high liquidity. Here is a list of the largest crypto exchanges by trading volume according to the CoinMarketCap rating:
- Coinbase Pro
- Huobi Global
Exchange selection criteria
To make arbitrage possible without any special risks and in the most comfortable way, the exchange must meet the main criteria:
- Low commissions for trading, deposits and withdrawals;
- Fast deposit / withdrawal speed;
- No problems with deposits;
- High density of order books and large order volumes;
How to choose a currency
To choose a suitable asset for crypto-arbitrage, use a service for arbitrage, rate monitoring or a special scanner that directly track cryptocurrency rates on different crypto-exchanges. We’ll talk more about the latter in the next section. List of useful services for monitoring courses:
Tools (software) for cryptocurrency arbitrage
To make arbitration of cryptocurrency rates more efficient, traders use arbitrage auxiliary programs, which allows to partially automate monitoring:
- Crypto arbitrage bots;
- Comparison tools.
The arbitration scanner monitors cryptocurrency rates on several exchanges and identifies pairs in which cryptocurrency prices differ the most. Some scanners provide access to trading and withdrawal via API to simplify and speed up the process for traders.
Cryptocurrency arbitrage bots
An arbitration bot can not only detect the difference between the rates on different crypto-exchanges, but also carry out operations on its own, without the participation of a trader. Robots react faster than humans and can monitor the crypto market around the clock, increasing potential income. But not every beginner will be able to correctly configure the robot for automatic crypto-arbitrage, if he has not worked with them before.
We wrote about such arbitrage tools in the previous section. This is the easiest way to track crypto asset rates that any beginner can handle, but it will be more time consuming as the software can detect matching pairs in milliseconds.
Pros and cons of crypto arbitrage
The advantage of crypto-arbitrage over other methods of making money on crypto-currencies lies in simplicity and lower risks for beginners. Newbies often lose money, for example by investing in cryptoassets before correction or investing heavily in mining equipment. Let’s talk about the pros and cons of crypto arbitrage.
- Relative simplicity for beginners;
- The ability to quickly make a profit with low risks;
- No need to undergo training in trading and investing in cryptocurrencies;
Doesn’t require large investments.
- Risks of losing money or missing out on profits if the exchange delays the withdrawal / replenishment of funds for a long time or temporarily disconnects wallets;
- The risk of a rapid fall in the rate of cryptoassets;
- There may be a long wait for arbitration opportunities.
Other reasons associated with the inexperience or carelessness of beginners.
In this article, I talked about what crypto arbitrage is, how to make money on it for beginners, what tools to use for this, and what are the advantages and disadvantages of this method of making money on cryptocurrencies. You can master crypto arbitrage without experience, but beginners need to know about the pitfalls in order to reduce risks and not make mistakes that will lead to loss of funds.
More articles on cryptocurrency here.