Arbitrage is one of the ways to make money in financial markets including digital currency. When a cryptocurrency has a price difference in two different exchanges, the Arbitrage strategy is used to make a profit from this price gap.
With these explanations, it may seem simple to make a profit from this work method, but it is not. To understand this issue, we need to first explain what arbitrage is and then discuss how to make money from it.
We will also take a look at the types of arbitrage, the legality of this work, choosing the right exchange and the advantages and disadvantages of arbitrage.
Let’s dive in and explore together:
- What is digital currency arbitrage?
- How to make money from arbitrage?
- Crypto arbitrage on a smaller exchange
- Is arbitrage legal?
- Different types of arbitrage in the digital currency market
- Advantages and disadvantages of digital currency arbitrage
- Choosing the right exchange for arbitrage
- Is digital currency arbitrage profitable?
- Frequently asked questions on Arbitrage
What is digital currency arbitrage?
Arbitrage simply means buying an asset in one place and selling it at a higher price in another place. Arbitrage can be defined in the digital currency market as follows: buying cryptocurrencies at a lower price from Exchange A and selling them at a higher price at Exchange B.
This is all that is used in the arbitrage method. But this method has subtleties and details and cannot be done easily.
Arbitrage means buying cryptocurrency from one exchange and selling it at a higher price in another exchange.
The basic point in arbitrage is the difference in the price of a single asset in two different exchanges. If there was only one exchange like Binance in the whole world, then there would be no price difference.
But with a large number of digital currency exchanges around the world, the possibility of arbitrage is available. This expansion causes the price difference.
In addition, supply and demand is another reason behind price chatter. Therefore, it is not possible to implement a mechanism to equalize the price. You can find out about this simply by comparing the prices of exchanges.
How to make money from arbitrage?
Traders can perform arbitrage manually. But in this method, time is an important factor. A price difference occurs temporarily in the market.
On the other hand, monitoring the price of hundreds of digital currencies in dozens of different exchanges is practically impossible. Keep in mind that the difference in the price of a token in two exchanges may only last for a few minutes.
It is very unlikely that you will be monitoring that token at that moment. The faster you complete the arbitrage process, the higher your profits will ultimately be.
For this reason, traders are turning to platforms that perform digital currency arbitrage transactions automatically using trader robots.
The steps of conducting arbitrage in the digital currency market are:
- The first step to arbitrage in the cryptocurrency market is to choose exchanges with high trading volume. The market must have enough depth to carry out the transaction. To view these exchanges, you can use the information of the Coinmarketcap website.
- In the next step, you should monitor the price of a specific asset in all or some of these exchanges and if there is a suitable price difference, buy that digital currency from the exchange with a lower price.
- After that you have to sell the asset in another exchange that has a higher price. For example, the price of one token on the Binance exchange is $100, and the price of the same token on the Hubei exchange is $105. You need to buy the token from the Binance exchange and transfer it to the Hubei exchange.
- The last thing is related to token sale and profit withdrawal. As long as this is the right price difference, this can be done many times and increase the amount of profit.
Crypto arbitrage on a smaller exchange
In the cryptocurrency market, there are many exchanges whose popularity is not the same. For example, compare a small local exchange in your country with the Binance exchange, which is the largest exchange in the world.
Bitcoin is traded in both exchanges and naturally does not have the same price. If Bitcoin is traded in the range of 17,000 dollars in the Binance exchange and 15,000 dollars in your local exchange, the price in which exchange is the benchmark?
This price difference should be resolved and the prices should converge.
Naturally, the price of Bitcoin on the local exchange will increase by $2,000, not that the price of Bitcoin on the Binance exchange will decrease by $2,000.
In this case, the trader can buy Bitcoin in the local exchange and keep it until the prices converge and sell it as soon as the price of the more reliable exchange is reached.
In this method, there is no need to transfer assets between two exchanges and costs are reduced.
Is arbitrage legal?
The short answer to this question is yes. The price of buying and selling a cryptocurrency in different exchanges is determined based on various factors, and if a user notices the difference in prices, he can take advantage of this opportunity and make a profit. No illegal action happens in this process.
The price difference created between the price of a cryptocurrency in different exchanges is not the result of arbitrage by a person or a group of users.
By the way, the more users apply for arbitrage, the sooner the asset price will reach equilibrium in different exchanges.
Therefore, it can be said that arbitrage helps stabilize the market and increase the volume of transactions.
Different types of arbitrage in the digital currency market
There are different types of arbitrage transactions, in this section we only mention the ones related to digital currency:
Cross-exchange arbitrage
The basic type of arbitrage is the same as what we explained so far. It means buying an asset at a low price from one exchange and selling it at a high price at another exchange.
Triangular arbitrage
In this method, assets are moved between three or more digital currencies in an exchange in order to gain profit from their price difference.
For example, the trader exchanges Bitcoin for Ether (BTC/ETH) and then Ether for Ada (ETH/ADA). Finally, it converts ADA back into Bitcoin. If there is a price difference between any of these pairs, in the end the trader will make a profit. In this method, there is no need to move digital currency between exchanges, and there is no transfer fee, but in reality, there are fewer opportunities to use this method. Also, arbitrage on the price difference between pairs of digital currencies and fiat currencies (such as BTC/USD and BTC/EUR) is also placed in the same category.
Spatial Arbitrage
Another form of inter-exchange arbitrage. The only difference is that the exchanges are geographically in different places such as America and South Korea.
Decentralized arbitrage
This method of arbitrage is done using a decentralized exchange and an automatic market maker. If the price of an asset on a decentralized exchange differs from its spot price on a centralized exchange, traders can trade.
Negative arbitrage
This method is done by borrowing and selling an asset and buying it again at a lower price.
Statistical arbitrage
This method is done with the help of data models and trader robots. In this way, the arbitrageur can perform high frequency trading (HFT) and complete a large number of trades in just a few minutes.
Advantages and disadvantages of digital currency arbitrage
Making money in the financial markets is not easy. Arbitrage is no exception to this rule and requires sufficient control over the market.
The arbitrage strategy in the digital currency market has advantages and disadvantages, some of which we will mention below.
Advantages
- Due to the high speed of arbitrage trades, there is generally a low risk in this method. Because the positions do not remain open for a long time and if you use reliable robots, the possibility of earning profit and success will be high.
- Due to the large number of digital currency exchanges, there are many opportunities for arbitrage.
- It is possible to do this method both in the rising market and in the falling market.
- Earning profit in this method is generally fast.
Disadvantages
- The delay in confirming transactions due to the density of networks may cause price changes and traders’ losses.
- Fees are high in some exchanges.
- The chance of arbitrage is reduced in exchanges with low trading volume.
- In working with different exchanges, you may need authentication, which will make your work difficult.
- The price of a digital currency may be very low on an exchange, but the orders are not filled.
- With low capital, there is no economic justification.
All of the above shows that although arbitrage is a seemingly simple way to make money, it has its own difficulties in practice. This method is not recommended for beginner traders.
You should also know both digital currency exchanges well and be sure that you will not have any problems when withdrawing assets from an exchange.
Choosing the right exchange for arbitrage
In choosing an exchange for arbitrage, you should pay attention to several important issues. The first point of discussion is the mandatory KYC for cryptocurrency withdrawal in most domestic and foreign exchanges.
So you should be aware that you have completed the authentication at the exchange of origin and destination.
The second case refers to the volume of exchange transactions. The low liquidity and volume of transactions make you unable to buy and sell at the desired price and you may suffer.
The third issue is exchange fees. In your calculations, you must include transaction fees and exchange withdrawals. Fees can have a big impact on your arbitrage profit.
Also, you should consider the transmission network fee. It is better that the exchanges you are looking for support networks with lower fees such as layer 2.
The last important thing is the deposit and withdrawal limits. Usually, to get profit from arbitrage, you have to buy and sell with a lot of capital.
In exchanges, especially domestic exchanges, there are restrictions on deposits and withdrawals that do not allow you to arbitrage with all your capital.
Be sure to get the necessary information about the restrictions of exchanges.
Is digital currency arbitrage profitable?
The profitability of arbitrage depends on several factors. As we said, time plays an important role in this process and many factors can affect this parameter.
For example, we can refer to the confirmation time of the transaction in blockchain networks or the deposit and withdrawal limits of exchanges.
On the other hand, the digital currency market has a high price fluctuation and the arbitrage opportunity may be lost very soon.
Arbitrage has other risks. The issue of slippage in decentralized exchanges or the order not being filled in centralized exchanges is an issue that affects your buying and selling price.
Also, due to the need for high speed, you may make mistakes during the transaction. For example, send cryptocurrency to a destination exchange that doesn’t support it for a lower fee.
To sum up this section, we must say that the nature of arbitrage is profitable. But many factors can change the amount of this profit or even lead to a loss.
To get arbitrage, you need to do accurate calculations and have sufficient knowledge of blockchain and trading networks.
Frequently asked questions on Arbitrage
What is arbitrage?
Arbitrage means buying an asset at a low price on one exchange and selling it at a higher price on another exchange. This price difference leads to profit.
Is arbitrage illegal?
No, this is not against the law, but doing it carries risks.
Is it safe to use an arbitrage robot?
The robot can be used both to monitor the market and discover price differences, and to make transactions. The use of arbitrage trading robots may involve the risk of fraud.
Is it safe to use a cryptocurrency arbitrage website?
You should also be very careful with websites that do cryptocurrency arbitrage. In the past, many websites provided this possibility for their users. But unfortunately, we realized that these websites, which had many users worldwide, are no longer active today. For this reason, we suggest that for arbitrage transactions, you must rely on programs written by you or at your suggestion.
Get information from different exchanges using API and make trades with your trading robot.
Arbitrage is a common way of making money in the financial markets, and the profit of this method is the result of buying at a lower price and selling at a higher price.
In this article, we first said what digital currency arbitrage is, and then we provided explanations about the method of earning money and types of arbitrage.
Legality, advantages, disadvantages, profitability and choosing the right exchange for Arbitrage are other things that have been discussed in the article. Have you ever done arbitrage? What do you think is the probability of success in this method?