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Cryptocurrency Arbitrage: a short introduction Tuesday October 22nd, 2019 – Posted in: cryptoarbitrage software
Arbitrage trading involves taking advantage of price differences that crop up in financial markets. Typically, for a number of reasons, the same financial asset might be trading at different prices on different platforms or exchanges. Arbitrage traders scour the markets to trade based on these differences. Until recently, arbitrage trading was limited to traditional financial assets, which meant that arbitrage trading was the preserve of larger players who had considerable resources and the necessary technology. The advent of cryptocurrencies has changed the game, empowering smaller market participants by giving them access to a new market.
The cryptocurrency market is a great place for arbitrage. Price differences usually occur as a result of market-related inefficiencies. The more inefficient the market, the more room there is for price anomalies and, therefore, arbitrage opportunities. This makes the cryptocurrency market an attractive place for arbitrage traders – it is decentralized, with a variety of exchanges offering the same cryptocurrencies. The large number of exchanges increases the possibility that the same cryptocurrency will occasionally trade at different prices on various exchanges. When the difference is sizeable enough, there is an opportunity to make money.
There are several kinds of cryptocurrency arbitrage. One involves trading two or more cryptocurrencies on the same exchange. For example, you can deposit US dollars on the exchange Kraken, use it to buy Ethereum coins, sell the Ethereum coins to buy EOS coins, and sell the EOS coins in exchange for US dollars. The benefit of doing it on one exchange is that you won’t need to pay commission fees on transfers between different exchanges (more on that later). However, this is generally considered to be a more complicated kind of trading and is therefore less popular.
A more conventional kind of arbitrage trading involves taking advantage of price differences on the same cryptocurrency between multiple exchanges. How does it work in practice? You might see that Bitcoin (BTC) is trading at $8,500 on Kraken and at $9,000 on Huobi. You’d then buy BTC on Kraken at $8,500, transfer it over to Huobi, and sell it there for $9,000.
It sounds simple enough on paper, but things are rarely so simple in real life. Cryptocurrency arbitrage comes with its own set of risks and limitations. Commission fees are a considerable hindrance for any arbitrage trader as they reduce trading profits. You can expect to pay a commission fee when you buy, sell, and even transfer coins from one exchange to another. For your arbitrage trading to be profitable, the spreads between prices have to be large enough to leave you with a profit after all the commission fees have been paid.
The cryptocurrency market can be volatile, and prices can change quickly. As it takes time to transfer cryptocurrency coins between exchanges, the market can easily move against you before you can make a profit from the arbitrage trade. You also need to factor in growing competition. An increasing number of arbitrage traders are moving into the cryptocurrency world, and that reduces the number of available arbitrage trading opportunities. Success also comes easier to arbitrage traders with greater financial resources – you need to work with higher trading volumes in order to be able to pay all the commission fees and still turn a profit. Last but not least, cryptocurrency exchanges are exposed to various security risks (e.g., hacking attacks), and crypto assets held in an account with a cryptocurrency exchange are never absolutely safe.
With that in mind, the cryptocurrency market still has much to offer to the well-prepared arbitrage trader. It is very much a developing market, and the high number of exchanges means it is also a decentralized one. While volatility can be a problem, it can also be your friend – price swings are conducive to arbitrage situations. To mitigate the effects of volatility, it is advisable to enter orders when the market is calm and not when it’s active.
Be prepared to monitor the market continuously to avoid losing out on arbitrage opportunities or being caught off-guard by adverse market developments. There are a number of sites where you can monitor cryptocurrency prices across numerous exchanges (Bitcoinity is one example). Stick to those cryptocurrency exchanges that have a good reputation, and are considered to be safe and reliable. Finally, look for price spreads of at least 2% before entering a trade so that you’re able to pay the commission fees and make a profit, and make sure that your deposit is at least $100.