What Is Crypto Arbitrage? How Does It Work? – Forbes Advisor INDIA

Understanding How Crypto Arbitrage Trading Works

Crypto arbitrage is one of the methods traders use to capitalize on price differences in cryptocurrency across exchanges. Due to the price volatility of cryptocurrency, imbalance in its supply and demand, and varying price discovery methods, trades that happen in it are often bought at a lower price from one exchange and sold at a higher price in another exchange to make profits.

Different Types of Crypto Arbitrage

Arbitrage is one of the oldest strategies used in trading that suits best for individuals who have a low-risk appetite. Over the years as the popularity of cryptocurrency gained traction, various strategies have emerged where traders try to gain as much profit via the arbitrage method. Even automated bots are being implemented that do most of the arbitrage analysis and monitoring. 

We’ve identified basic crypto arbitrage methods, as follows:

Simple Arbitrage

This arbitrage strategy, also known as cross-exchange arbitrage, is the most common method designed on a principle where a trader buys crypto coins at a lower price from one exchange and sells them at a higher price at another exchange.

For instance, if you buy a Litecoin (LTC) at a value of INR 7,098.28 ($85.48) on Coinbase and sell it at INR 7,222.01 ($86.97) on Binance, you will earn INR 123.73 ($1.49) profit.

Spatial Arbitrage

Spatial arbitrage is similar to cross-exchange arbitrage, however, the strategy takes advantage of price differences of the cryptocurrency at exchanges located in different regions. Profit is earned on the spread value, however, the transfer between exchanges may take time, and it may lose its value.

Triangular Arbitrage

As the name suggests, such an arbitrage strategy takes place when paired three cryptocurrencies with temporary price differences among exchanges.

For instance, let’s assume the following exchange rates of Bitcoin (BTC), Litecoin (LTC), and Dogecoin (DOGE):

After converting 1 BTC to LTC using the BTC/LTC pair, we receive 400 LTC. Then exchanging the 400 LTC for DOGE using the LTC/DOGE pair, we get (400 x 0.02) 8 DOGE. Finally, when we sell the 8 DOGE for BTC using the DOGE/BTC pair (8 x 0.02), we get a profit of 0.16 BTC—which represents the gain from triangular arbitrage.

Advantages and Disadvantages Associated with Crypto Arbitrage

Arbitrage being a low-risk strategy, the profit that is gained often corroborates with a lower return. That being said, there are pros and cons associated with crypto arbitrage.

Advantage of Crypto Arbitrage

• Quick returns: Traders can gain immediate returns after identifying price differences of cryptocurrencies across exchanges.
• Beginner-friendly: Depending on the type of arbitrage method, even beginners in crypto can start making a profit.
• Cross-border trading benefit: Traders can take advantage of price differences of crypto at exchanges located in different regions.
• Implement bots: Automated bots can do most of the crypto arbitrage analysis and monitoring efficiently, but the cost is usually high. 

Disadvantage of Crypto Arbitrage

• Volatility: Due to the price volatility of cryptocurrency, and time taken for the transfer among exchanges may increase the risk of losses.
• Lower returns: Due to low-risk appetite, profits earned from the arbitrage method usually fetch lower returns.
• Geographical regulations: Traders must comply with the region’s legality and feasibility of crypto arbitrage.
• Monitoring: Requires constant monitoring of price differences of cryptos across exchanges, and calculate profits accordingly.
• Delay: As most arbitrage methods occur between two or more exchanges, withdrawal delays, and technical challenges may incur losses.
• Account setup: Requires setting up accounts across multiple exchanges, and having a multiple wallet setup, etc.
• Fees: Crypto arbitrage is not exempt from fees. Crypto exchanges charge withdrawal fees, platform fees, etc., which in return can minimize your profit margin.

How To Implement Crypto Arbitrage Strategy

Although crypto arbitrage is a low-risk strategy, it doesn’t mean that you won’t lose money. Before making a leap towards a crypto arbitrage strategy, it is important to obtain appropriate financial advice and only invest what you can afford to lose.

Be familiar with the process of cryptocurrency trading. Crypto trading refers to buying and selling of cryptocurrencies, like bitcoin or Dogecoin, at crypto exchanges. It requires extensive research to gain an understanding of price movements, trading strategies (like those mentioned above), the process of buying and selling crypto, fees, and regulations, as well as getting familiar with using the platform.

Create multiple exchange accounts. The first step to start crypto arbitrage trading involves creating accounts across multiple crypto exchanges, as the arbitrage strategy usually involves buying crypto coins at a lower price from one exchange and selling them at a higher price at another exchange.

Create multiple wallet setups. A crypto wallet is a software program used to manage cryptocurrency where you can send, receive, and store Bitcoin, Litecoin, Dogecoin, and other cryptocurrencies. You may require different wallets as the support can vary as per the type of coins.

Bottom Line

Crypto arbitrage involves identifying price differences across exchanges to make gains from the risk-free strategy. That being said, arbitrage requires research and in-depth knowledge of crypto trading, and usually a large amount of capital, as well as becoming familiar with the trading tools of a platform to execute the strategy correctly.

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