What is Crypto Arbitrage and how does it work?
Cryptocurrency (and crypto arbitrage trading) is different from traditional markets. Instead of having a couple of highly regulated, “official” exchanges, in crypto there are dozens of exchanges. Even if you only count the major exchanges it’s still quite a list.
Because crypto trades on all of these exchanges simultaneously, there is no official price for a coin like BTC. There is no reason why BTC can’t trade for $50,000 on Binance and $49,500 on Coinbase, or vice versa. Short-term supply and demand on platforms can create a situation where the same asset is priced differently depending on the exchange.
That’s where arbitrage trading comes in. What is arbitrage?
Crypto arbitrage is when a trader buys crypto on one platform and sells it on another to take advantage of price discrepancies. Based on the example above, a trader could sell 1 BTC on Binance for $50,000 and buy 1 BTC on Coinbase for $500 cheaper. That’s a fast and low-risk way to earn $500.
Speaking of profits, there are a couple of good reasons why traders engage in crypto arbitrage:
- Compared to traditional trading, a crypto arbitrage doesn’t come with much risk. A trader should only be holding the crypto for minutes or tens of minutes, just as much time as it takes to buy on one platform and sell on another. An arbitrage trader shouldn’t be exposed to massive price swings or be at risk of liquidation from a leveraged long or short position.
- Nearly unlimited opportunities. There are dozens of cryptocurrency exchanges and hundreds of coins. With enough effort a crypto arbitrage trader should be able to find some opportunities to profit. Smaller market cap coins can be especially profitable. Professional arbitrage traders focus on large coins like BTC and ETH, but there are still lots of opportunities to trade low-volume altcoins.
- The extreme volatility of crypto creates arbitrage opportunities. Crypto may be the best asset class on the planet for arbitrage since it is so volatile. Large swings can create large discrepancies in pricing, I.e. arbitrage opportunities. A 20% move in the stock market is massive, whereas a 20% move in BTC is common.
- There is less competition in the crypto markets. If you look at the stock markets, there are many sophisticated traders and institutional investors who are doing arbitrage. There are fewer of these big players in crypto. They’re starting to come in and every year there will be more of them, but for now it’s still possible for a retail arbitrage trader to make good money in the crypto markets.
As you can see, there are lots of reasons to start doing crypto arbitrage. As with anything, the harder you work at it the more money you can make. Arbitrage opportunities don’t tend to hang around long, so it’s important to act fast when you identify them. In the next section we’ll look at what is arbitrage and some of the best techniques to make money from it.
Crypto Arbitrage Methods
There are several popular arbitrage techniques. The simplest is to buy crypto on one exchange and sell it on another.
A good example of this trade is the Coinbase premium. Coinbase is arguably the most trusted exchange in the world. At least, it is the most trusted exchange in North America. Many investment firms and institutional buyers like to use Coinbase because the exchange is based in the USA and is highly regulated.
Because of the institutional demand for Bitcoin on Coinbase, sometimes crypto starts to trade for a premium on the exchange. The price of all cryptocurrencies, but BTC in particular, can end up being higher on Coinbase than on other platforms that don’t have as much institutional demand.
A common crypto arbitrage is to buy BTC on another exchange and sell it on Coinbase for a profit. One thing that’s great about crypto arbitrage is that it’s not hurting or taking advantage of anyone. Arbitrage is an essential part of every market and it ensures that prices remain fair.
This type of crypto arbitrage we just explained may be the simplest form of arbitrage, but it’s not always easy to pull off. Several problems can occur with this type of crypto arbitrage.
- High withdrawal fees. Sometimes an exchange can charge high withdrawal fees which can eat into the profits for an arbitrage trade.
- Long confirmation times. Withdrawing Bitcoin from one exchange to another typically takes 30 minutes at a minimum. Sometimes it can even take 1 hour, if the exchange requires 6 confirmations before the deposit clears.
- Locked accounts. Sometimes an exchange can lock an account so that a trader can’t withdraw his or her coins. This is especially likely to happen if a trader is making lots of withdrawals in a short amount of time.
Because of the high fees and slow confirmation times, the best coins to arbitrage between exchanges are those that are fast and cheap to send. XLM, XRP and NANO are a few of the coins that work best for this type of arbitrage trade.
A More Sophisticated Crypto Arbitrage Method
A more sophisticated approach to crypto arbitrage is to hold cryptocurrencies on two different exchanges. Whenever there is a price discrepancy, the arbitrage trader can buy crypto on one exchange and sell it on another at the same time.
This trade is more sophisticated because it requires that an arbitrage trader keeps significant amounts of cryptocurrency on different exchanges. The more exchanges the better, since it’s not possible to always predict where an arbitrage opportunity will appear.
Crypto Arbitrage: What can Go Wrong?
One of the most common questions is what can go wrong with crypto arbitrage? If crypto arbitrage was super easy and nothing could go wrong then everyone would be doing it. The following are a few of the most common problems that crypto arbitrage traders have to deal with.
Low Trading Volume
If there’s not enough trading volume on an exchange a crypto arbitrage trader’s order may not execute at the price they want it to. This is known as slippage: not getting the quoted price on the trade. Slippage is less common on smaller trades, but gets increasingly common as the size of the trade goes up.
Since crypto arbitrage is a low margin activity, slippage can take away from the already slim profits of trading. To avoid slippage a crypto trader can do arbitrage on the largest exchanges with lots of volume. Arbitrage traders can also focus exclusively on the coins with the most trading volume, like BTC and ETH.
Crypto arbitrage traders should also be aware of order book depth. Sometimes algorithmic traders can make an order book look like it has depth but when you try to execute a trade the buyers and sellers disappear.
Even though crypto is the future of finance, we still haven’t figured out great scaling solutions for this new technology. Bitcoin is more than a decade old but it can still only clear about 7 TPS (Transactions Per Second) and Ethereum isn’t much better. During the height of the 2017 bull market some BTC transactions got stuck for days.
The problem with arbitrage is that at the exact moment when you need to send crypto the most, the network is probably going to be congested. If the fee is too low the transaction can get stuck and it might not process until the arbitrage opportunity is gone.
Trading Fees Go Up, Trading Profits Go Down
Since crypto arbitrage requires a lot of trading, profits are affected by trading fees. The higher the trading fees, the lower the potential profit. The problem with exchanges is that they can change their trading fees at any time.
For example, in 2019 Coinbase Pro raised their maker & taker trading fee to 0.5%. Hiking up the trading fee this high was an increase of about 200% over what they were charging before. For retail traders exchanging a few hundred dollars at a time it’s not a big deal, however, for professional arbitrage traders that increase can make a big difference.
Getting the Timing Wrong
Being a successful crypto arbitrage trader means having great timing. The best arbitrage opportunities may only exist for tens of minutes or an hour or two. After that another arbitrage trader is going to come in and close the deal.
Since nobody can be at their computer 24/7, one way to increase your success with crypto arbitrage is to use an arbitrage bot. These bots can be programmed to execute multiple arbitrage functions across different exchanges and with different cryptocurrencies.
Doing Crypto Arbitrage with a Bot
Using a bot is one of the easiest ways to increase your profits from crypto arbitrage trading. Since bots trade 24/7 they can capture trading opportunities that you would typically miss.
Ideally a trader will have enough coding experience to program their own bots. Programming a bot allows for ultimate customization. However, preprogrammed bots are also available.
How to create a Bitcoin arbitrage bot?
One of the first replies to what is arbitrage is that it’s a trading activity that can be automated. Crypto trading bots can be programmed to do all sorts of interesting things and the best trading bots can be very profitable.
Some crypto arbitrage bots can be downloaded for free since they’re open source projects. Other bots are only available as part of a paid subscription. The simplest bots are easy to set up, while more complex functions may need to be programmed into a bot. Common programming languages for crypto bots are C++ and Python.
What are the best crypto arbitrage bots?
Here are three of the best crypto trading bots.
A lot of crypto arbitrage traders use Blackbird since it’s open source and can be downloaded for free. Setting up Blackbird requires some coding experience, especially in the C++ language.
Cryptohopper is a premium arbitrage bot with lots of cool features. Traders can backtest their strategies, trade more than 100 cryptocurrencies and set up market making opportunities in addition to arbitrage. Cryptohopper isn’t free, it’s a subscription service that costs anywhere from $19 to $99 per month.
Zenbot is another open-source trading bot. The project is actively maintained and Zenbot is constantly being upgraded. The downside of Zenbot is that it’s a command line trading bot, which requires the trader to know how to execute functions with a CL interface.
Is Crypto Arbitrage Profitable?
Crypto arbitrage can be very profitable, however, it’s not necessarily easy. Many of the best money making opportunities get quickly arbed away by professional traders. It can take time and a lot of research to find a way to make reliable profits.
Once a crypto arbitrage trader finds their niche though, they can start to earn reliable profits, especially in a rising bull market.
This content is for informational purposes only and is not investment advice. You should consult a qualified licensed advisor before engaging in any transaction.