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How to arbitrage crypto through trading

Buy low, sell high – crypto arbitrage trading sounds easy in theory, but its no longer as easy to make a tidy profit as it once was.

With cryptocurrency trading still in its early days and markets spread all around the world, there can sometimes be significant price differences between exchanges.

Cryptocurrency arbitrage allows you to take advantage of those price differences, buying a crypto on one exchange where the price is low and then immediately selling it on another exchange where the price is high.

However, there are several important risks and pitfalls you need to be aware of before you start trading.

Disclaimer: This information should not be interpreted as an endorsement of cryptocurrency or any specific provider, service or offering. It is not a recommendation to trade.

How to arbitrage trade crypto

To short-sell Bitcoin, you'll need a trading account and a clearly mapped-out trading strategy.

  1. Open an account with an exchange.
    To arbitrage trade crypto, you will need several cryptocurrency exchange accounts created before hand. This will allow you to quickly switch between exchanges and seize any arbitrage opportunities. Check here for an extensive list of crypto exchanges in Australia.
  2. Setup your trade environment.
    Arbitrage opportunities can be identified manually, with the aide of software or a bot, or a combination of both. You will need to decide which option works best for you and setup your workspace accordingly. This could involve using multiple monitors to track prices and news, while another is dedicated to your exchange trading window.
  3. Monitor prices and news.
    To give yourself the best change of identifying an arbitrage opportunity you will need to constantly track price fluctuations on a wide number of exchanges. You may be able to get an edge by closely monitoring news for events that could move the market.
  4. Trade execution and risk management.
    Arbitrage trading benefits from speed, but you still need to exercise caution. Before entering your trade, you should have mapped out your entry price and reason for entering, your potential profit target and a stop-loss in case the market moves against you. You will also need to calculate the cost of any withdrawal or gas fees involved in transferring your crypto from one exchange to another, which will impact the profitability of your trade.
  5. Move your profits to a secure wallet.
    As with all trading, it's generally a good idea to take profits frequently so that you're gains are locked in and you're not tempted to add them to your trading capital. For the best security, consider moving your funds off an exchange and into a personal crypto wallet to mitigate any exchange risks, like hacks or fiscal mismanagement. Alternatively, you could withdraw them as AUD to your bank account.

What is crypto arbitrage?

Arbitrage involves the concurrent purchase and sale of a security on various markets to take advantage of price discrepancies between them. For instance, you would look for a coin or token that is priced lower on Exchange A compared to Exchange B. You would then purchase the coin on Exchange A and sell it at a higher price on Exchange B, thus making a profit from the price difference.

The concept of arbitrage trading is not a new one and has existed in stock, bond and foreign exchange markets for many years. However, the development of quantitative systems designed to spot price differences and execute trades across markets, including crypto, has put arbitrage trading out of reach of most retail investors.

How does crypto arbitrage trading work?

Arbitrage is typically made possible by a difference in trading volumes between 2 separate markets. The reason behind this is simple: in a market with high trading volumes where there's reasonable liquidity of a particular coin, prices are generally cheaper. Meanwhile, in a market where there's limited supply of a particular coin, it will be more expensive. By purchasing from the former and instantaneously selling on the latter, traders can theoretically profit from the difference.

However, arbitrage opportunities also exist in the opposite direction, where you would buy on a smaller exchange and sell on a larger exchange. The recent surge in the popularity of cryptocurrency has led to a dramatic increase in trading volumes on many exchanges around the world. Those exchanges are not linked, and a low trading volume on some exchanges can mean that the price listed doesn't adjust to the exchange average immediately. As a result, this has seen the creation of price differences arbitragers could potentially exploit.

The most famous example of crypto exchange pricing differences was a phenomenon known as the "kimchi premium" which, in January 2018, saw the price of Bitcoin (BTC) in South Korea rise to around 50% higher than global prices.

Crypto arbitrage trading example:

To explain how arbitrage works, let's look at a hypothetical example. Let's assume we have 2 exchanges that both list Bitcoin:

  • Exchange A is a major exchange with a high trading volume. The price of BTC on this exchange is US$8,800.
  • Exchange B is a smaller exchange with less trading volume. The price of BTC on this exchange is US$8,805.

Now let's assume that there's an important announcement that is likely to encourage people to buy BTC, such as the US Internal Revenue Service announcing that all BTC deposits will never be subject to tax. This prompts widespread demand for BTC, and most buyers head to the biggest exchanges because they offer the easiest way to buy cryptocurrency.

This surge of buyers causes an increase in BTC prices on large exchanges like Exchange A, while Exchange B sees less trading volume and its price is slower to react to the change in the market. BTC reaches US$9,240 on Exchange A, but only rises to US$9,070 on Exchange B, which is where arbitrage comes in. You could do the following:

  1. Buy BTC on Exchange B at US$9,070.
  2. Transfer your BTC to Exchange A.
  3. Sell your BTC on Exchange A for US$9,240, securing a profit of US$140 per BTC.

Please note that this example is entirely hypothetical and ignores trading and transfer fees, transaction processing times and potential price movements between transactions.

* This is a fictional, but realistic, example.

Arbitrage trading strategies

The most basic approach to cryptocurrency arbitrage is to do everything manually – monitor the markets for price differences and then place your trades and transfer funds accordingly. However, there are several cryptocurrency arbitrage bots available online, designed to make it as easy as possible to track price movements and differences.

It's also worth pointing out that hedge funds are increasingly moving into the cryptocurrency sphere. For example, Singapore hedge fund Kit Trading is raising US$10 million for a crypto arbitrage fund and is set to join the more than 80 crypto hedge funds that launched in 2017.

There are multiple strategies arbitrage traders can use to make a profit, including the following:

Simple arbitrage

Buying and selling the same coin immediately on separate exchanges.

Triangular arbitrage

This process involves taking advantage of the price differences between 3 currencies. For example, buy BTC in USD, sell it to make EUR, and then exchange those EUR back to USD.

Convergence arbitrage

This approach involves buying a coin on an exchange where it is undervalued, and short-selling the same coin on another exchange where it is overvalued. When the 2 separate prices meet at a middle point, you can profit from the amount of convergence.

Arbitrage trading bots

Arbitrage trading bots are similar to what professional quant trading firms use. They are automated programs that scan the market to spot opportunities and execute trades on behalf of the user. Beware that some bots may require access to your funds, and may be prone to error or front-running if you're trading on-chain.

Potential benefits of crypto arbitrage

Why would you consider cryptocurrency arbitrage? There are several reasons:

  • Fast way to (potentially) turn a profit. You can complete an arbitrage deal in as little time as it takes you to complete all the relevant trades. This offers the potential to realise gains much faster than if you're taking the traditional approach to buying and holding cryptocurrency before selling at a later date.
  • Huge range of exchanges. According to CoinGecko there are now more than 700 major centralised and decentralised exchanges around the world. With so many exchanges available, in so many different markets, there's plenty of potential to spot arbitrage opportunities.
  • Cryptocurrencies are volatile. Choose Bitcoin or any other top-traded cryptocurrency and take a look at a graph charting its price for the past 12 years (or whichever time frame is appropriate for the cryptocurrency you are researching). This is a great way to understand just how volatile crypto prices can be – and wherever there's volatility, there's the potential for price differences between exchanges.

Risks of crypto arbitrage

Cryptocurrency arbitrage sounds like a piece of cake in theory, so why isn't everybody and their dog doing it? Well, there are several barriers you'll need to overcome and risks you'll need to be willing to accept in order to trade profitably:

  • KYC regulations. Know Your Customer (KYC) regulations can place barriers on entry to many exchanges. For example, you may need to hold a bank account in the same country where an exchange is based in order to be allowed to place trades, or you may need to have your account verified (which could take 24 hours or more) before you can trade. To avoid this, consider opening an account with major exchanges beforehand.
  • Storing coins on exchanges. To place arbitrage trades, you'll need to store coins on crypto exchanges so they're ready for use whenever you need. There have been plenty of examples of exchanges getting hacked, not to mention some stealing money from customers, so you'll need to be aware of this risk before getting started.
  • Fees. Most crypto exchanges charge fees on trades, while deposit and/or withdrawal fees sometimes also apply. The biggest fee of all can be gas fees, which are fees paid to the blockchain network to move assets between wallets. If network congestion is high, you may end up paying a three-figure sum just to move your funds around. You'll need to factor these fees into your calculations when determining the profitability of a trade.
  • Large trades often required. Once you take into account processing delays and all the fees that apply, profits from successful arbitrage trades may be small. As a result, you'll often need to buy and sell large volumes of crypto in order to magnify your returns.
  • Withdrawal limits. If you're looking to place large trades, be aware that many exchanges limit the amount you can withdraw from your wallet per day, so it may not be possible to withdraw the coins you want to execute a profitable arbitrage deal.
  • Failing to execute in time. Another risk with arbitrage is if the market moves against you or a trade is already taken before you can execute your sell trade. Cryptocurrencies are highly volatile, so the price could rapidly move against you in the time it takes to move funds from one exchange to another.
  • Slow transactions. With the recent surge in trading volume on global cryptocurrency markets, many exchanges have struggled to keep up with demand. There have been numerous instances of delayed withdrawals, which could be highly problematic if you're looking to move funds as quickly as possible. Transaction times can also vary depending on the coin you're transferring – for example, Ethereum (ETH) transactions are processed much more quickly than BTC transfers.
  • Competition risk. As more traders become aware of the potential advantages of arbitrage, there may be increased competition for trades. This is especially true for large firms which use software to constantly monitor the market and identify opportunities faster than most retail investors can.

How to find crypto arbitrage opportunities

Cryptocurrencies are complicated and highly speculative and, as we've outlined above, arbitrage comes with its own risks attached. You'll need to make sure you're fully aware of those risks before you even attempt to execute an arbitrage deal.

If you've thoroughly researched how arbitrage works and you understand the risks involved, keep the following tips in mind before getting started:

  • Monitor the news. News events can have a major impact on price. In some cases they will only impact prices in one market (like say Japan or the US) but not in others which provides an arbitrage opportunity.
  • Monitor exchange prices. The most obvious step in arb trading is to monitor prices of your favourite assets on major crypto exchanges. But don't forget about the smaller exchanges, or decentralised exchanges which run on blockchains like Ethereum. Decentralised exchanges use an Automated Market Maker (AMM) system which is essentially designed to provide arbitrage opportunities to traders.
  • Monitor Automated Market Maker (AMM) exchanges. AMM's are explicitly designed to provide arbitrage opportunities to traders in order to keep asset pools evenly balanced. They do this by pooling two assets (eg, ETH/USDT) and let traders buy or sell either asset from the pool. Over time, if one asset is more popular than the other then the pool becomes imbalanced and arbitrage traders step in to restore balance and potentially secure a profit. You can learn more about how AMMs work in this guide.
  • Monitor multiple blockchains. Sometimes the value of an asset on one blockchain (eg, USDC on Ethereum) will deviate from the price of the same asset on another blockchain (eg, USDC on Solana). Keep in mind you will need to bridge assets between both chains which can become costly.
  • Look for new listings. Keep track of crypto forums and news sites for announcements of a new coin being added to an exchange. If a coin has only been recently added to an exchange and there is only limited demand for the coin on that site, you may be able to find a larger price differential.
  • Don't transfer funds using BTC. Speed is of the essence when doing this type of trading, so BTC's slow transaction time could hurt your chances of making a profitable trade. You may want to consider transferring funds between exchanges using a stablecoin on a network like Ethereum, which offers faster transactions, instead. Better yet, use a layer-2 like Arbitrum or Optimism for cheaper gas fees.
  • Have a plan. There are several key questions and factors you'll need to consider before starting. For example, how much money should you put in? What percentage difference between prices will represent a sufficiently profitable opportunity? Will you keep a balance of coins on multiple exchanges or transfer your funds around as needed, thereby increasing delays?
  • Only use trusted exchanges. While there's always a certain level of risk when dealing with any crypto exchange, do plenty of research beforehand to make sure you only deal with reputable platforms.
  • Monitor the market. There is a greater chance of price differences during periods of market volatility, so monitor crypto markets for any news and developments that could cause rapid price changes.
  • Hedge. To protect against sudden market moves that aren't in your favour, it's worth reading up on hedging strategies and how to use them.
  • Diversify. Only channelling your money into a single exchange, or a single type of cryptocurrency, is risky. Spreading your money around can help to minimise risk.
  • Limit your exposure. Never arbitrage an amount that is more than you can afford to lose. With so many potential risks that could lead to a loss, it's always a good idea to play it safe.

Compare crypto exchanges in Australia

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OKX
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Swyftx
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CMC Invest
BPAY, Bank transfer (Direct Deposit)

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Bottom line

The volatile nature of cryptocurrency means that arbitrage opportunities are abundant, especially thanks to the introduction of DeFi. However, making a tidy profit from arbitrage is not as easy as it onces was. Automated software and bots now hunt for arbitrage opportunities constantly, making it harder for entry level traders who are only equipped with a keyboard and mouse. To get an edge you will need to create a plan, research the field in depth, monitor the market closely and consider using specialised software or tools.

FAQs

Disclaimer: Cryptocurrencies are speculative, complex and involve significant risks – they are highly volatile and sensitive to secondary activity. Performance is unpredictable and past performance is no guarantee of future performance. Consider your own circumstances, and obtain your own advice, before relying on this information. You should also verify the nature of any product or service (including its legal status and relevant regulatory requirements) and consult the relevant Regulators' websites before making any decision. Finder, or the author, may have holdings in the cryptocurrencies discussed.

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