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Crypto Arbitrage Trading Explained

crypto arbitrage trading explained

Crypto arbitrage is a trading strategy in which investors profit from minor price differences in a digital asset across different markets or exchanges. This profit is achieved by purchasing a digital asset on one exchange and then selling it on another for a higher price.

Thanks to Crypto Arbitrage, traders can earn their income from a process that takes little to no risk. Another advantage of this strategy is that you don’t have to be a professional or high-volume investor with an expensive setup to start using it.

Arbitrage Trading and Crypto

Arbitrage was a hallmark of traditional financial markets long before the crypto market emerged. Nonetheless, there’s an even bigger interest emerging for arbitrage opportunities across the crypto scene.

This is most likely due to the crypto market’s reputation for being more volatile in comparison to other financial markets. Due to their volatility, crypto asset prices tend to differ dramatically over time.

Another reason is that crypto assets are traded globally across hundreds of exchanges around the clock. This way, arbitrage traders have a considerably greater opportunity to uncover profitable price differences.

In short, the crypto arbitrage trader’s primary objective is to detect a difference in the pricing of a digital asset across two or more exchanges. Once he detects it, he conducts a series of transactions to profit from the price difference.

Types of Crypto Arbitrage

There’s no lack of strategies when it comes to crypto arbitrage. So below, we bring you the three most popular ones.

Cross-Exchange Arbitrage

Buying a cryptocurrency on one exchange and then transferring it to another to sell it at a higher price is the most basic type of crypto arbitrage.

Assume a trader notices that Binance charges $1,950 for 1 ETH, while Kraken charges $2,000. In theory, he could benefit from this by buying 1 ETH on Binance, transferring it to Kraken, and then selling it for a $50 profit.

But there are some downsides to this type of arbitrage that you should be aware of.

For starters, crypto exchanges charge transfer fees, which occur when moving crypto from one exchange to another, as well as trading fees in some cases. Furthermore, the price difference is often only present for a few seconds but shifting across exchanges usually takes longer.

Arbitrage traders can keep transfer fees to a minimum by holding currency on two different exchanges. In this way, they can buy and sell cryptocurrencies almost simultaneously.

It’s important to remember that you can take advantage of stablecoins in order to reduce trading fees even further. That’s because it costs much less to keep your profits in stablecoins than it does to convert them to fiat currencies.

Statistical Arbitrage

Statistical arbitrage is the practice of trading cryptocurrency using quantitative data models. A statistical arbitrage algorithm could trade hundreds of different cryptocurrencies at once and figure out how likely it was that each trade would make money.

In general, a statistical arbitrage bot will give a cryptocurrency that performed exceptionally well a higher score and a cryptocurrency that performed poorly a lower score. Then, it will use mathematical analysis and machine learning to find the best way to trade in the future based on what it has learned.

The best trading bots will be good at making mathematical models that can predict the price of cryptocurrencies and trade them against each other.

Triangular Arbitrage

This strategy entails taking three different cryptocurrencies and trading the difference between them on the same exchange. In this case, transfer fees are no longer relevant because your assets stay on the same platform.

For example, a triangular arbitrage trader may spot an opportunity in arbitrage involving Ethereum, Solana, and Cardano. One or more of these cryptocurrencies may be undervalued on the exchange.

In turn, a trader may take advantage of arbitrage possibilities by selling Ethereum for Solana, then using that Solana to buy Cardano, and finally buying Ethereum with Cardano. When the strategy works, the trader ends up with more Ethereum than they started with.

Crypto Arbitrage Concerns

While crypto arbitrage trading is considered one of the lowest-risk trading strategies, there are still some things you should be wary of. If you want to learn more, check out our list below.

Trading Fees

Trading fees are one of the most significant challenges for traders that are new to crypto arbitrage, especially since they can vary greatly.

When Ethereum congestion was at its peak, for example, its users experienced extremely high gas fees. Given the speed and volume of arbitrage trading, these transaction fees can quickly add up.

High-frequency trading is far less expensive in other markets when compared to crypto. While blockchain technology promises to reduce fees to nearly nothing, it still has a long way to go before it gets there.

Security

Keeping your cryptocurrencies on exchanges exposes you to a greater risk than storing them in a private crypto wallet. That’s because exchanges are more likely to be targeted by attacks and government regulations.

Due to the high trading frequency of crypto arbitrage trading, withdrawing and depositing to a crypto wallet is not an option. So it’s important to acknowledge this fact when deciding if this trading strategy is for you.

Gas Fees and Delays

Price slippage occurs when you receive a different price than expected on a trade entry or exit. That’s why rigorous market research and excellent market timing are critical components of arbitrage trading.

Higher gas fees are often associated with delays in order execution time. Transactions can take several minutes, if not longer, to clear, especially on cryptocurrency exchanges. Due to this, an arbitrage opportunity may not exist after five minutes or more.

Conclusion

Arbitrage is a classical trading method that even retail investors can benefit from. It’s easy to learn and doesn’t require you to make a big initial investment.

Thanks to the crypto market’s high volatility, arbitrage trading has been growing in popularity lately, and many investors are taking advantage of it.

While there are many cryptocurrencies and exchanges available today, the time frames for exploiting arbitrage opportunities are extremely short. That’s why it might no longer be viable to perform crypto arbitrage manually.

Instead, you should learn to use trading algorithms and bots for this type of trading. At this point, it’s the only way to keep up with the market.

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