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What Is Arbitrage Trading in Crypto?

Wednesday, April 26, 2023

What Is Arbitrage Trading in Crypto?

Arbitrage trading involves buying a crypto asset on one exchange and selling it immediately on another exchange at a significantly higher price.

The concept of Arbitrage trading is neither new nor exclusive to the crypto markets, as it has existed in the stock, bond, and foreign exchange markets for many decades. Just like the traditional financial markets, the concept of arbitrage in crypto centers around leveraging the prices of crypto assets to your advantage.

What Is Crypto Arbitrage?

Arbitrage is the simultaneous buying and selling of an asset in different markets to profit from the price difference. In simpler terms, arbitrage trading involves buying a crypto asset on one exchange and selling it immediately on another exchange at a significantly higher price.

For example, if the price of Bitcoin is $30,100 on Binance and $29,900 on Zipmex, an arbitrage trader can buy the Bitcoin on Zipmex and sell it on Binance to pocket the difference. Being successfully at arbitrage trading comes from having a solid understanding what is crypto liquidity.

How Does Arbitrage in Crypto Trading Work?

Using the previous example of Bitcoin and Zipmex, these opportunities occur rather frequently due to a rapid surge in trading volumes or inefficiencies within the exchange.

Bigger, more established exchanges often have better prices that are closer to the real-time trading prices of crypto assets. Automated market makers have helped this process as well. However, the prices on smaller exchanges may be higher or lower because of inefficiencies within the exchange. Thus, the concept of Arbitrage trading seeks to leverage the imperfections of the crypto markets.

Major factors that affect prices on exchanges are their liquidity and the trade volumes registered on the exchanges. The higher the trading volumes of a crypto asset on an exchange, the lower the variation from its actual price would be. On the contrary, the prices of crypto assets tend to be higher on smaller exchanges with low liquidity. There are also tools such as liquidity pools which provide crypto liquidity services to help make the process of trading easier.

There are mainly two types of crypto arbitrage:

  • Arbitrage between exchanges (also known as Triangular Arbitrage): the Bitcoin–Zipmex example is a good case of triangular arbitrage. Because crypto can be easily transferred over a blockchain network, there are often opportunities for arbitrage between exchanges.
  • Arbitrage within the exchange: for this to happen, you would need to purchase two different crypto assets, such as Bitcoin (BTC) and Ethereum (ETH), from the same exchange and sell it when there's a price difference.

Cross-border arbitrage involves buying and selling crypto on two exchanges situated in different countries.

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Is Arbitrage Trading of Crypto Profitable?

Like every other trading technique, crypto arbitrage has helped traders earn profits from the crypto market. Every day, there are significant differences in the ask-bid prices of crypto assets, even among popular exchanges.

On average, crypto arbitrage trades can earn profit margins between 0.2% and 2.5% ($10 to $50) daily. However, there are occasions where there are large differences in spreads offering traders the opportunity to make decent profits, but this doesn't happen every day. Arbitrage traders are often day traders who usually focus on the differences in spreads daily.

An important aspect of arbitrage trading is quick execution–when traders spot differences in prices across exchanges, they quickly decide to buy or sell the crypto asset. The volatility of the crypto market makes quick response pertinent for successful arbitrage trading as the price differences can be wiped out with significant delays.

Risks Involved in Arbitrage Trading of Crypto

Cryptocurrency arbitrage is legal; however, the inherent volatility of crypto assets poses some form of risk to traders. The inherent volatility of crypto assets is perhaps the most notable risk. Some transactions take around fifteen to twenty minutes to be validated, and in that time, there can be drops or rises in the market prices. You may risk generating a loss or profit when this happens.

Other factors to consider before venturing into arbitrage trading of cryptocurrencies are the fees charged by the exchanges, their Know Your Customer (KYC) requirements, withdrawal limits, and the transaction of the house exchange.

In Conclusion

Crypto arbitrage trading can be a profitable venture for traders. However, you need the right set of tools and knowledge to be successful in this venture. In choosing exchanges for arbitrage trading, always look out for the liquidity of the exchanges, as more liquid exchanges offer better opportunities to easily sell and buy the crypto assets.

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Our investment strategy involves providing deep liquidity crypto market making to the projects we invest in. This approach allows us to ensure continuous and substantial liquidity in exchanges. By doing so, we aim to increase market efficiency and reduce price volatility. We help to stabilize prices and reduce the bid-ask spread, which can lower transaction costs for traders. This usually attracts more traders to the markets, by making it easier and less risky to trade your token which can help to increase the overall liquidity and trading volumes both for the benefit of traders and issuers. However, we recognize that providing liquidity also comes with potential risks, which we carefully evaluate and manage as part of our investment decision-making process.