October 12, 2022 - 7 min read
Like traditional arbitrage, a crypto trader can profit by buying at a low price on one exchange and selling at a higher one on another. However, the type of asset traded is the primary differentiator between crypto arbitrage and more conventional forms of arbitrage.
In the world of finance, crypto arbitrage trading refers to a method that involves buying and selling cryptocurrencies at the same time to create a profit. The objective is to generate a profit by taking advantage of any price differences between the various exchanges used for trading cryptocurrencies and simply repeat it until the arbitrage gap closes.
To profit on disparities in the spot price of a digital asset across two or more exchanges, a trader would need to identify the pricing discrepancy and carry out a series of transactions. If Bitcoin is selling for $15,000 on one exchange and $14,500 on another, for instance, a trader can buy Bitcoin on the exchange where it is selling for a lower price and then sell it on the exchange where it is selling for a higher price, pocketing the difference of $500 (deducting fees).
It is essential to be aware that arbitrage trading is a high-risk method that ought to be performed only by seasoned investors who have sufficient resources. This method carries with it the potential risk of a rapid volatility in the asset’s price, which has the potential to result in suffering huge losses.
Trading arbitrage in cryptocurrency works in the same way in conventional markets. Traders must immediately buy and sell an asset across platforms anytime they become aware of a price inefficiency. The only distinction is that traders who engage in cryptocurrency arbitrage concentrate on crypto assets such as Bitcoin and Ethereum.
Buying and selling digital assets from one cryptocurrency exchange to another is the essence of the arbitrage trading strategy. Larger and more established cryptocurrency exchanges typically have better values than the levels at which crypto assets are traded in real-time. In addition, automated market makers have been of assistance throughout this process. However, due to the inherent inefficiencies of the exchange, the prices on the more specialized exchanges tend to deviate further from median spot prices. As a result, the idea of arbitrage trading tries to capitalize on the faults that exist inside the cryptocurrency markets.
The liquidity of the exchanges and the amount of trade volume registered on the exchanges are two significant elements that influence the pricing of the exchanges. When a cryptocurrency asset has higher trading volumes, the difference between the price listed on an exchange and the actual cost is anticipated to be minimal. On the other hand, prices of cryptocurrency assets tend to deviate further from spot prices on smaller exchanges with lower liquidity levels.
However, certain conditions must be met for a crypto arbitrage to occur:
1. There must be a difference in the prices of an asset across different marketplaces. For example, arbitrage in cryptocurrency is typically executed using the same assets but at different market prices.
2. The two transactions have to take place at the same time on different exchanges. For example, on one market, the token is purchased at a discounted price, and then sold on another exchange at a premium price, keeping the profits.
1. Cross-Exchange Arbitrage: This is the most basic form of arbitrage trading, in which a trader attempts to make a profit by buying Bitcoins on one exchange and selling it on another. This is the most basic form of arbitrage trading. This is because the values of the same assets might fluctuate between different exchanges, making this conceivable. To capitalize on the price differential, the trader needs to be quick on their feet and have accounts on both exchanges.
2. Spatial Arbitrage: The exchanges located in various sections of the country are just one of the differences. For instance, you might be able to profit from the disparity between the supply and demand for Bitcoin in the United States and Japan by employing spatial arbitrage.
In the cryptocurrency market, spatial arbitrage is applied to transactions involving the same asset that are priced differently on various exchanges. It is also utilized in transactions involving comparable assets whose values vary but tend to converge.
3. Triangular Arbitrage: It is a process in which funds are transferred on a single exchange between three or more digital assets to profit from a price difference between one or two cryptocurrencies. This approach is also known as “three-way arbitrage.” For example, a trader can establish a trading cycle that begins and ends with Bitcoin.
One of the biggest cryptocurrency markets is in South Korea, where 10% of all Bitcoin trades take place. According to economists, the absence of high-yield investment choices for investors in South Korea, the nation’s interest in technology, and the prevalence of gambling, there is a price difference for cryptocurrencies on South Korean exchanges compared to overseas exchanges known as the “kimchi premium.” But regulations against money laundering, bank regulation, and capital controls make this procedure problematic.
For illustration, on December 15, 2017, the price of Bitcoin reached a high of $18,479 on Coinbase, a cryptocurrency exchange based in San Francisco. The price of Bitcoin reached a high of $21,000 on the South Korean exchange Bithumb that same day. Trading professionals could earn up to 14% on price differences in Bitcoin by timing their trades properly. They would have to use Coinbase to purchase Bitcoin and Bithumb to sell it in order to accomplish this.
Arbitrage trading in cryptocurrency can be a lucrative investing technique since it enables investors to profit from price differences in various digital currencies. However, engaging in this form of trading has its share of potential drawbacks.
The trading of cryptocurrency arbitrage is, first and foremost, fraught with significant levels of risk. If the market goes against you, the chance of making a substantial profit in a short time can result in enormous losses. In addition, cryptocurrency arbitrage trading is sometimes predicated on relatively minor price fluctuations, which are straightforward to manipulate. Last but not least, there is always the possibility of falling victim to dishonest brokers or traders. Therefore, when engaging in a business of this nature, it is critical to remember the importance of exercising extreme caution.
However, cryptocurrency arbitrage trading is the safer option compared to other trading methods. You will likely not always earn a considerable profit when you purchase and sell cryptocurrency on two exchanges simultaneously. Still, likely, you will not make a significant loss either.
However, because arbitrage traders are required to deposit large sums of money into exchange wallets, they are vulnerable to the security risks of exchange hacks and exit scams. Scams involving an exit occur when a company abruptly stops its activities and then makes off with the monies of its customers. In light of this, conducting thorough research is prudent and limiting one’s cryptocurrency trading to recognized platforms only.
Before you start engaging in arbitrage trading of cryptocurrencies, you need to make a few other considerations first. These include the fees charged by the exchanges, the requirements they have for Know Your Customer (KYC), the withdrawal limits, and the transaction of the house exchange.
Because of this, crypto arbitrage is a good alternative for consumers who want to avoid making long-term investments in the volatile cryptocurrency market.
Arbitrage is a trading method for cryptocurrencies that has the potential to generate profits. It is possible to achieve decent returns from this method by profiting from disparities across asset prices, provided you have sufficient seed capital and self-discipline. However, because cryptocurrencies are digital and are not based on an underlying asset, it isn’t easy to place a value on these currencies.
Arbitrage methods can be even more intricate than the cryptocurrency itself, which is a lot, given how complicated cryptocurrency is. Yet, the technique is legal and has the potential to provide significant gains; however, it also puts an investor in a position where they are exposed to a considerable level of risk.
To level up and gain a deeper knowledge of all things related to the future of the cryptocurrency industry, check out the latest content in the Supra Academy section.
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