• Sat. Apr 20th, 2024

What Is Crypto Arbitrage Trading And Is It Profitable?

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Table of Contents

What Is Arbitrage Trading?
Is Crypto Arbitrage Profitable?
Types of Arbitrage Trading Strategies
Arbitrage Trading Considerations
Are Crypto Arbitrage Bots Profitable?
Platforms/Apps for Crypto Arbitrage
Final Thoughts

There’s no shortage of cryptocurrency enthusiasts touting how you can make money by investing in crypto. Hodling Bitcoin, trading bots, dollar-cost averaging, and arbitrage are some of the many strategies.

But if the word “arbitrage” is new to you, you might wonder, what is arbitrage trading in crypto? 

Crypto arbitrage is a relatively low-risk way to make money by buying an asset at a lower price on one exchange and selling it for a higher price on another. Fast transactions are crucial, and large profits typically require significant capital.

 

What Is Arbitrage Trading?

Arbitrage trading is the process of buying an asset for a lower price on one cryptocurrency exchange and immediately selling it for a higher price on a different exchange. The difference between the higher and lower buy-in price is your profit.

The concept of arbitrage has been around for many years in traditional markets. But cryptocurrency offers unique arbitrage trading opportunities because the market stays open 24/7. Moreover, some people even have access to trading on crypto exchanges in various parts of the world.

But worldwide trading isn’t a given, depending on your country of residence. That’s one of the reasons that crypto arbitrage opportunities happen.

For example, South Korea’s strict crypto policies prevent citizens from moving lots of money out of their country. They also don’t allow foreigners to invest in South Korean cryptocurrency exchanges.

As a result, the price of any given crypto asset on South Korean exchanges is often higher than in other parts of the world. It’s such a common occurrence that there’s even a name for it—Kimchi premium.

So, if a South Korean buys a crypto asset abroad, they can often sell it on a South Korean cryptocurrency exchange for a profit.  

Other scenarios that create crypto arbitrage opportunities include:

Exchange lag time

Favorable transaction and transfer fees

Different price reaction times across exchanges

Approximately 500 cryptocurrency exchanges exist in the world. Each exchange has its own order books, and the price of an asset on any given platform depends on the most recent bid-ask matched order.

So, although the price discrepancy among exchanges is often minor, they sometimes have lag times or vary in their price reaction times according to the interest of the investors on their platform. 

You might encounter lucrative crypto arbitrage opportunities if you work with high-volume trades and qualify to sign up for exchanges offering competitive transaction and transfer fees.

 

Is Crypto Arbitrage Profitable?

Crypto arbitrage can be profitable. But given that the price difference in exchanges is usually tiny, this trading strategy is most profitable when you have a large sum of money to invest.

For example, let’s say you purchase Bitcoin for $25,000 on Kraken and sell it for $25,300 on Binance. 

If you invest $25,000, you’ll receive a $300 profit minus exchange and Bitcoin transaction fees. But if you invest $1,000, you’ll only make $12. 

Even though using an arbitrage strategy is relatively low risk, low risk often comes with lower rewards. So, people with small bankrolls might not feel that the money they can earn from crypto arbitrage is worth the effort.

 

Types of Arbitrage Trading Strategies

It’s possible to use arbitrage trading strategies across centralized and decentralized exchanges. 

But the process looks different on the backend, given that trading arbitrage on centralized exchanges involves waiting for your order to be filled via an order book. In contrast, decentralized arbitrage trades execute right away since you’ll buy and sell a crypto asset already in a liquidity pool.

Below are some of the most popular types of crypto arbitrage trading strategies. For the sake of simplicity, we’ll use Bitcoin as the crypto asset in most of our examples.

Cross-exchange Arbitrage

Using the cross-exchange method is the classical type of arbitrage. In this case, you’ll identify Bitcoin selling for a lower and higher price across two different exchanges.

You’ll then purchase Bitcoin at a lower price and sell it at a higher price, keeping the profits.

Spatial Arbitrage

Spatial arbitrage follows the same concept as cross-exchange arbitrage. The difference is that you’ll buy and sell your crypto using exchanges in two different parts of the world. 

The example we shared about the Kimchi premium in South Korea showcases how spatial arbitrage works.

Interest Rate Arbitrage

Many cryptocurrency exchanges offer borrowing and lending options to their users. However, the interest rates they offer often vary.

So, you can borrow an asset like Bitcoin at a low-interest rate from one exchange and then lend it for a higher interest rate on another.  

Bot Arbitrage

Arbitrage trading can be time-consuming since you have to look for price discrepancies across multiple exchanges. But by using a bot program, your bots can automatically scout out and execute arbitrage opportunities for you.

We’ll discuss the bot arbitrage strategy and its profitability in more detail shortly.

Statistical Arbitrage

Bots use statistical arbitrage, but some traders with a background in designing or reading mathematical models may choose a personalized, statistical approach to arbitrage trading. Python is a popular tool for algorithmic arbitrage trading.

Doing so opens the potential opportunity for more arbitrage trades. However, this skill takes time, which is why many people rely on bots.

Triangular Arbitrage

Triangular arbitrage involves buying and selling three or more cryptocurrencies for profits without having to leave an exchange. Such a method is ideal for people with limited cryptocurrency exchange choices due to their country of residence.

An example of triangular arbitrage is buying a Bitcoin and exchanging it for Litecoin and Solana before converting Solana back to Bitcoin. Any price discrepancies along the way will add up and net you more Bitcoin if the arbitrage trade works in your favor.

Decentralized Exchange Arbitrage Example

Arbitrage on decentralized exchanges operates with liquidity pools rather than order books. That means people can automatically buy and sell their crypto assets, given that a pool of those assets is already in waiting.

Assets on a decentralized exchange vary in pricing according to the people who provide liquidity by voluntarily placing their crypto assets in a pool. A formula ensures the ratio of assets and their pairing remain balanced. Choosing between decentralized and centralized exchanges can be tricky, but it will be case-specific and depend on your needs.

But when a large buyer swoops in, it can offset the price of the purchased asset and the coin paired with it. 

The decentralized MakerDAO is one example. MakerDAO operates on the Ethereum blockchain and provides liquidity to its users through its stablecoin, DAI.

So, if you want to buy DAI from a DAI/BTC pool, you’d have to deposit Bitcoin (BTC) into the pool to be able to remove DAI. The result is that there will be more BTC in the pool than DAI.

The decentralized exchange will then lower BTC’s price and increase the price of DAI. The result is that more people will want to buy BTC, adding more DAI to the pool until the prices stabilize with the DAI and BTC’s prices on other exchanges.

In the meantime, arbitrage traders—including those that changed the ratio of the pool by making a large DAI purchase, can profit from the price differences.

 

Arbitrage Trading Considerations

Although it might seem like you can make money by using arbitrage trade crypto strategies, the reality is that many factors could hinder your profits. 

Some of the most essential items to know when considering the arbitrage technique include:

Slippage can happen

Fees can eat into profits

Low volume can delay trades

Blockchain transaction speeds vary

The cryptocurrency market is volatile

Exchanges or bots could go offline

Anti-money laundering checks cause delays

Requires high bankroll for significant profits

Security risks by keeping money in an exchange

You may not have access to all arbitrage opportunities

Our goal in sharing this isn’t to make you run away from arbitrage but to consider whether it’s the best crypto trading strategy for your situation. Below are details about some of the key takeaways of these points.

Timing Is Everything

The crypto market is notorious for being volatile, and since it’s open 24/7, there’s always the potential for a massive spike or drop. So, you could get unlucky and buy a crypto asset, and the market could plunge before you have time to exit your arbitrage trade in profit.

Another timing issue is the delay that sometimes happens to make a transaction on the blockchain. Some crypto assets execute trades within seconds. Others, such as Ethereum, experience periods of network congestion. 

So, suppose you choose to trade a cryptocurrency with slower average transaction times or at a time when the network has a lot of traffic. In that case, you could lose a profitable arbitrage trade while waiting for your buy or sell order to process.

Prices and Fees

Since the profit margin is typically so low in arbitrage trading, every fraction of a coin counts in your buy and sell trades. 

Slippage is the concept of your buy or sell order executing at a different price than you anticipated. In some cases, this can work in your favor. But slippage can also cause an arbitrage trader to lose some or all of their potential profits.

An exchange’s fees can also make a dent in your profits. If you’re not careful, you could even lose money from arbitrage trades due to higher than expected exchange fees.

High fees are most common for low-volume traders, as most centralized exchanges operate on a tiered system, offering lower trading fees according to their 30-day trading volume. And that doesn’t even include the blockchain transfer fees you’ll need to pay by transferring a crypto coin between exchanges.

It’s easy for newbies to miscalculate or underestimate the cost of exchange fees. For this reason, a bot can be helpful, as they typically factor in the anticipated cost of fees before choosing to execute a trade.

System Errors

Technology isn’t perfect. So, you can expect your arbitrage bots or cryptocurrency exchanges to occasionally have system errors, temporarily shutting their doors to trading.

Such a situation often happens during periods of high trading traffic. Unfortunately, this can correspond with an abundance of profitable trading situations. A cryptocurrency exchange might also temporarily halt trading a specific asset if they notice a significant price discrepancy on their platform compared to the broader market. 

Is Crypto Arbitrage Legal?

Arbitrage trading with crypto is legal in most parts of the world. The key is to trade between cryptocurrency exchanges that you can legally sign up for if you use an arbitrage strategy involving different platforms.

For example, due to strict cryptocurrency laws, South Koreans would have trouble implementing many of the arbitrage trading strategies discussed here if they involve crypto exchanges outside their country.

Americans also have limited access to cryptocurrency exchanges, given that the United States doesn’t license exchanges offering derivatives trading to the everyday investor. Nevertheless, it’s often still possible for people from countries with tighter crypto regulations to perform certain arbitrage trades.

 

Are Crypto Arbitrage Bots Profitable?

A crypto arbitrage bot can be profitable, but due diligence is essential to ensure the bot has a history of high performance.

The advantage of using cryptocurrency bots for arbitrage is that they can watch the entire cryptocurrency market simultaneously. They can also buy and sell a crypto asset faster than humans.

Therefore, you can often make more money with a well-functioning bot since the trades happen near-instantly. You can also expect a bot to perform more trades since they can spot them quickly, making them potentially more lucrative for people trading with a small amount of capital.

That said, all technology can malfunction. So, you need to be comfortable with the risks of letting a bot manage whatever amount of money you permit it to trade with. 

 

Platforms/Apps for Crypto Arbitrage

If you’re ready to try crypto arbitrage, below are some platforms and apps worth considering.

Pionex

Pionex defies the saying, “You have to spend money to make money,” because they offer a free arbitrage bot. 

Of the 16 bots that Pionex provides, they offer a free arbitrage bot that they call “Moderate Mode.” According to Pionex, their bot averages an annualized rate of return between 5% to 50%. You can use Pionex on your desktop and via an app on your mobile device.

Cryptohopper

Cryptohopper is on the expensive side for a bot, but it comes with high ratings and excellent resources for people new to crypto arbitrage. 

Furthermore, they have a system called Exchange Arbitrage, which allows your bot to identify and jump on arbitrage opportunities from several different exchanges without you having to transfer a crypto asset between them.

Coinrule

Coinrule is a more advanced bot while still being friendly for beginners. It allows you to set up and automate an arbitrage strategy without coding experience. 

You’ll be able to link your Coinrule account to multiple exchanges, such as Coinbase Pro, Binance, and Poloniex.

 

Final Thoughts

The answer to “What is crypto arbitrage?” is more nuanced than the uninitiated might expect, given that several arbitrage trading strategies exist.

Some crypto arbitrage traders might spend their days at their computers monitoring exchanges for price discrepancy opportunities, others may use bots to automate the process.

While arbitrage trading with crypto can be profitable and is less risky than certain other crypto investment strategies, there’s still potential for you to lose money. So, we encourage you to do your due diligence before deciding whether this is a trading method you want to implement.

Related: 

How to Read Candlestick Charts (Beginner’s Guide)
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