Tens of billions of dollars in cryptocurrency change hands every day with millions of trading transactions. Unlike the fiat stock exchanges globally, over a hundred cryptocurrency exchanges sell cryptocurrency via a varied market-making system at different prices for identical cryptocurrencies.
A skilled trader that dares to take a negligible risk for the opportunity to get the edge over their fellow traders can play these exchanges against each other. The rewards are big, and you can automate most of it using a bot.
Basics Of Crypto Arbitrage
Arbitrage trading cryptocurrency is a trading strategy that takes advantage of market inefficiencies. The main idea is to purchase an asset in one market and sell it immediately in another market. It is hopefully making a profit by selling at a higher price by exploiting the price difference.
The concept of crypto arbitrage is fairly self-explanatory. Basically, it's classic arbitrage using crypto as the asset. This strategy works because of how cryptocurrencies are priced differently on different exchanges. For example, on Coinbase exchange, one Bitcoin might be $10,000, while on Binance exchange, it could be $9,800. This price difference is the key to arbitrage. You can ideally buy Bitcoin on Binance, take it to Coinbase, and sell it—profiting by around $200 without the BTC fees involved.
What arbitrage requires most besides a winning strategy is speed. These price inefficient situations usually don't last very long. But the gains are sizable if the arbitrageur captures the inefficiency in time. For example, Filecoin went on sale in October 2020; among exchanges, the price was from $30 to $200 in the first few hours. Imagine the profits some in arbitrage trading made that day.
How Do Crypto Prices Work?
Most people have a shallow understanding of how pricing works on exchanges. The magic word here is order books. The order books of exchange, either controlled by a market maker or ones that utilize Automatic Market Maker algorithms, contain buy and sell orders at various prices. Order books basically match the buyers and sellers at a price point and record the trade at that price. This means that each exchange's price reflects what a buyer got and what a seller paid for the last transaction on that exchange.
Since none of the exchanges out there are synchronized on share prices, there's always a price inefficiency in the crypto market.
Different Types Of Arbitrage
• Between Exchanges
As discussed above, there are price inefficiencies between exchanges. You can effectively buy a cryptocurrency on one exchange and transfer it to another where the price is higher and pocket the difference. However, the only problem with this route is that any meaningful difference usually only exists for a matter of seconds, and transfers can take minutes. Add transfer fees are another issue, along with network fees.
How To Get Around This?
Many arbitrageurs get around the fees, and the transfer timing issue is by holding cryptos on two different exchanges. A savvy trader using this method can then simultaneously buy and sell a cryptocurrency.
• Triangular Arbitrage
The triangular method is a bit more involved, utilizing three different cryptocurrencies and pocketing the difference between them on one exchange, and eliminating the transfer fee quandary.
• Statistical Arbitrage
The great thing about Statistical arbitrage is the use of quantitative data models to trade crypto. A well-designed strategy is deployed using a statistical arbitration bot that trades hundreds of different cryptocurrencies at once. This method does careful calculations of the chance that a bot makes money on a trade based on a mathematical model and making effective use of going "long" or "short" on a trade.
In this method, a well-designed bot will give a cryptocurrency that's surged in price a really low score and one that has performed poorly a high score. Advice from an experienced blockchain consultant can help you choose between all the possible options already on the market or develop your own custom bot. A well-designed trading algorithm will utilize mathematical models that can predict the price of cryptocurrencies, pitting them against each other.
Final Thoughts On Arbitrage Advantages
In conclusion, if you are looking to gain while using price inefficiencies in the crypto market, this is an excellent way to start looking at various exchanges and learning more about arbitrage.
