What is crypto arbitrage? A simple guide to the basics

If you have been trading crypto for a while, you will have noticed the price variations across exchanges.

Even Bitcoin, the largest and most liquid cryptocurrency, trades at different prices on separate markets, opening up the opportunity for savvy traders to engage in crypto arbitrage trading. Read on to learn what crypto arbitrage is, how it works, and whether you can still make money within today’s market.

What is crypto arbitrage? Crypto arbitrage explained

Arbitrage is the simultaneous buying and selling of an asset to profit from the imbalance in its price. Arbitrage trading entails traders exploiting the price variability of financial instruments on different markets. What is arbitrage in crypto?

Cryptocurrency arbitrage trading is a trading strategy where a trader buys a crypto asset on an exchange and sells it to another exchange to profit from a price deviation between the two markets. 

For instance, you can purchase Ethereum (ETH) at $2 543 on Binance but it’s currently trading at a bid price of $2 656 on Kraken. The discrepancy in the crypto exchange prices offers a $113 opportunity for arbitrage.

Based on this scenario, arbitrage trading may look simple but that isn’t always the case. Several factors influence arbitrage trading such as market risk, hidden costs, barriers to entry, and more.  

Arbitrage traders take advantage of the inefficiency of the crypto markets, which leads to price discrepancies across global exchanges, opening up crypto arbitrage opportunities.

Interestingly, crypto arbitrage trading doesn’t only occur cross-exchange but also within a single exchange and exchanges in different regions.

How does crypto arbitrage work?

To understand how cryptocurrency arbitrage works, first, you need to know how the pricing of crypto assets works on exchanges. 

In a centralized exchange, pricing depends on the most recent price at which a digital asset is purchased or sold, which becomes the real-time price of that asset on the exchange. 

For example, if a trader places an order to buy Bitcoin (BTC) for $70,000, and it is the most recently matched order on the exchange, the price will become BTC’s latest price on the exchange.

On the other hand, most modern decentralized crypto exchanges rely on a different method to price their assets, called an automated market maker protocol, which leverages smart contracts to replace the order book.

Decentralized exchanges use liquidity pools to maintain the prices of crypto assets. Each liquidity pool represents a crypto pair. For example, an ETH/SUSHI liquidity pool on SushiSwap allows you to convert your ETH to SUSHI tokens and vice versa.

A liquidity pool contains funds provided by liquidity providers who deposit crypto assets to earn their corresponding share of the pool’s trading fees. The ratio of assets in the pool is balanced by utilizing a smart contract deployed by the decentralized exchange.

Types of crypto arbitrage 

There are several ways crypto arbitrage traders can make money off-market inefficiencies. These include the following crypto arbitrage strategies:

Types of arbitrage	Details
Cross-exchange arbitrage	Cross-exchange arbitrage is where a trader tries to make a profit by buying a cryptocurrency on one exchange and selling it on a different one.
Spatial arbitrage	Spatial arbitrage happens cross-exchange but with the exception that the exchanges are located in separate regions. For example, you could take advantage of the price disparity of BTC/USDT in the US and Asia.
Triangular arbitrage	Triangular arbitrage involves spotting price discrepancies of digital assets on a single exchange and executing a trade for profit. For example, you can purchase XLM using BTC, sell XLM to ETH, and finally exchange your ETH for BTC. Three different crypto assets changed hands, hence the term ‘triangular.’
Decentralized arbitrage	Decentralized arbitrage involves exploiting price differences on DEXs and centralized exchanges.
Statistical arbitrage	Statistical arbitrage deploys algorithms and trading programs to execute high-frequency arbitrage trading on different exchanges.

Arbitrage in cryptocurrency gives traders the chance to seize opportunities created by price differences on different exchanges. By employing different strategies like spatial, triangular, and statistical arbitrage, they can deftly maneuver through the quick-paced market, aiming to increase their returns. While the potential rewards are significant, successful arbitrage requires quick execution, a deep understanding of market dynamics, and a keen awareness of risks involved.

How to perform crypto arbitrage step-by-step?

Here’s a quick guide on how to perform cross-exchange crypto arbitrage.

Step 1: Pick your exchanges. Start by selecting a few reputable cryptocurrency exchanges like Binance or Coinbase. Don’t forget to check their fees — understanding these costs is key. 

Step 2: Spot price differences. Keep an eye on real-time prices across these exchanges using price tracking tools. Look for those moments when you can buy low on one platform and sell high on another.

Step 3: Fund your accounts. Make sure you’ve got funds ready to go in each exchange. It’s best to have some crypto and fiat money on hand.

Step 4: Make your moves. Buy the cryptocurrency where it’s cheaper, then transfer it to the exchange where you can sell it for a profit.

Step 5: Watch transaction times. Be mindful of how long transactions take. Picking coins that get confirmed quickly can really boost your chances of making a profit.

Step 6: Calculate your earnings. After selling, subtract any trading and transfer fees from your total to see what you really made.

Step 7: Cash out. Once you’re satisfied with your profits, withdraw them to your bank or wallet to secure your earnings.

Step 8: Stay updated. Keep monitoring market trends and tweak your strategies to stay ahead of the game.

With these steps in your toolkit, you’ll be ready to explore crypto arbitrage more confidently, just remember to watch out for any potential risks.

Risks of crypto arbitrage

Sadly, arbitrage in cryptocurrency comes with its own complexities. Price swings, unexpected costs, and the possibility of slow transaction times can all impact how well your arbitrage strategy works. Understanding these risks is crucial for traders looking to navigate the complex world of cryptocurrency effectively. Let’s take a closer look at some of the key risks associated with arbitrage in crypto.

Speed is essential

To be a successful arbitrage trader, you need to execute your trades quickly to profit from price differences of an asset from exchange to exchange. The downside to these trades is your transactions can drive up the buying price and result in a decline in the sale price of an asset. If not timed correctly, you may make a loss on a subsequent transaction.

Exchange liquidity

The lack of liquidity on some exchanges makes it hard for arbitrage traders to make a profit as the exchange may not have enough volume to execute a large transaction. This means a trader may have to wait for a while to get the right buyer and risk missing the arbitrage window or altogether forfeiting the trade.

Transaction costs

Exchange transaction fees may add up and eat into a significant chunk of your arbitrage profits. 

Slow transaction speeds

When crypto markets are on the move it is common to have slow transactions or downtime at crypto exchanges. Arbitrage traders stand to lose money in such situations. You can counter this by having a large position of working capital at a few exchanges.  

Withdrawal limits

Some exchanges have withdrawal limits, which makes it difficult for crypto arbitrage traders to access their profits immediately.

Best crypto arbitrage platforms

It’s crucial to consider your specific needs and trading objectives while selecting the finest crypto arbitrage platform. Each platform has a unique collection of features, expenses, and advantages that could or might not be suitable for you. To assist you in making an educated choice and increase your income, we have broken out the top crypto arbitrage bots.

Pionex

This good exchange comes with in-built Bitcoin and crypto trading bots. The arbitrage bot in Pionex is free to use. However, the total package comes with a very low fee that is affordable.

Bitsgap

You might have heard about this crypto arbitrage platform. It is a very popular cloud-based system that supports some centralized exchanges such as Binance, Huobi, etc.

Coinrule

This arbitrage bot makes it easy for you to perform arbitrage. It does not require prior skills in coding. Although intuitive, it is easy to set up and use. It comes with military security that offers encryption at its finest.

FAQs

Is crypto arbitrage legal?

Yes. Crypto arbitrage is legal. Similar to how arbitrage is used in the global capital markets, crypto arbitrage is a legal method that allows traders to earn a potential profit when an asset is selling cheaper in one exchange and at a higher price on a different exchange. 

Digital currencies trade on different multiple exchanges, and oftentimes the price of a token will differ from one exchange to another. In addition, crypto arbitrage helps to improve market efficiency.

Is crypto arbitrage still profitable?

Absolutely, crypto arbitrage can still yield profits, but you might find that chances come around less frequently as the market grows more efficient. 

There are still opportunities for traders to spot price differences between exchanges. But success largely depends on transaction fees, market volatility, and your ability to act swiftly. Staying informed and adaptable is key to maximizing returns.

How to find arbitrage opportunities in crypto?

Crypto arbitrage opportunities can be found on most centralized and decentralized exchanges, as both exchanges have varying prices for the different digital assets traded. 

For centralized exchanges, the pricing of assets is dependent on the latest bid-ask matched order on the particular exchange. Simply put, the last price that a trader buys or sells a crypto asset on a centralized exchange is regarded as the asset’s real-time price.

On the other hand, decentralized crypto exchanges utilize a different pricing method for crypto assets called an automated market maker. AMMs depend on crypto arbitrage traders to ensure the prices remain in line with those on other exchanges.