What is arbitrage in crypto trading?

Arbitrage trading has become incredibly popular, particularly within the cryptocurrency industry where the sheer number of exchanges available presents traders with a perfect opportunity to take advantage of price discrepancies. Although the profits may be small, it is possible to collect a lot of them if you know what you’re doing, and it’s relatively low-risk.

So, what exactly is arbitrage, and how can you take advantage of it to earn a profit? In this AAG Academy guide, we’ll explain what makes arbitrage trading possible, and touch upon how you can get started with cryptocurrencies.

What is arbitrage?

Arbitrage is the process of simultaneously buying and selling the same asset or security in multiple markets to take advantage of differences in price.

Exchange rates are constantly changing all the time, and it often takes foreign exchanges a little bit of time to catch up. This sometimes gives quick traders the opportunity to purchase a security at a slightly undervalued price, while simultaneously selling it on their local market and then collecting the difference as a small profit.

For example, Samsung is a cross-listed company and its stock can be purchased on both the South Korean and U.S. stock markets. On any given day, the exchange rate between the Korean won and the U.S. dollar is fluctuating constantly, but it takes the markets time to catch up. So, it may be possible to buy Samsung stock for less on one market than on the other.

Let’s say, for instance, that Samsung’s stock price is currently $1,150 in the U.S., but in Korea, it is available for ₩1492962.96 — which, at the current exchange rate, is $1,146. It would be possible to purchase that stock on the Korean market while simultaneously selling it on the U.S. market, netting you a profit of $4.

Although it may sound like a complicated process, arbitrage trading is actually fairly straightforward — especially for those who have made a habit of it — and therefore is considered to be a fairly low-risk practice. However, the profits earned on each trade tend to be very low, so traders will often carry out many of them on a daily basis.

What is cryptocurrency arbitrage?

Arbitrage in cryptocurrency uses the same concept, except it does not rely on foreign markets and exchange rates. Most cryptocurrencies are available on many exchanges — sometimes hundreds of them — and it is impossible for every exchange to maintain exactly the same price at the same time. Therefore, there are almost always differences in value between them.

Sometimes, although not very often, those differences can be fairly big. One of the reasons for this is that most cryptocurrencies are decentralized, unregulated, and not pegged to traditional fiat currencies (with the exception of stablecoins), so there is no standard price for any particular coin or token that every exchange can follow.

In addition, some exchanges are significantly bigger than others, with much greater trading volumes, so the supply and demand on one exchange can be very different to that of another.

Just like in the stock market, then, there are opportunities to buy cryptocurrencies on one exchange while simultaneously selling them on another at a higher price to earn a profit.

What are the different types of arbitrage?

There are many different types of arbitrage, some of which you may want to be aware of if you’re currently trying to decide whether you want to be an arbitrage trader. Here are three key types in the finance and cryptocurrency industries:

Spatial arbitrage
Spatial arbitrage, which is the method we’ve outlined above, is one of the most common types. It involves buying an asset or security in a foreign market while simultaneously selling it in another to take advantage of price discrepancies between the two.

Cross-exchange arbitrage
Cross-exchange arbitrage, which is most common in the cryptocurrency industry, involves buying an asset on one exchange and then immediately selling it on another.

Triangular arbitrage
Triangular arbitrage is the most complex of the three methods. It not only involves taking advantage of pricing inefficiencies between different pairs of cryptocurrencies on the same exchange, but it requires three trades to earn a potential profit.

Traders start with one cryptocurrency, then trade it for another cryptocurrency on the same exchange. They then trade it again for a third cryptocurrency that is overvalued compared to the first two. Finally, they trade that third cryptocurrency for the one they started with, which — as assuming everything goes to plan — will leave them with more coins or tokens.

What are the benefits of crypto arbitrage?

You may have already recognized that the biggest benefit of cryptocurrency arbitrage is the opportunity to earn a small profit by simply buying and selling coins and tokens very quickly. Because price differences tend to be relatively small, it is a low-risk trading method, which means you are unlikely to lose significant capital should things go wrong.

There are some important things to bear in mind, however. Arbitrage trading is only effective when it is done very quickly, so you’ll need to know exactly what you’re doing and have a concrete plan before initiating a trade. It is also incredibly important to take trading fees into account, since the cost of making multiple trades can outweigh any potential profits.

How to take advantage of crypto arbitrage

One of the best things about arbitrage trading within the cryptocurrency industry is that there are a number of platforms available today that can automate the process — not only for finding price discrepancies across multiple exchanges, but also for carrying out the trade itself. This gives traders an opportunity to earn a small but passive income with little effort.

ArbiSmart is one of those platforms, and it uses “state-of-the-art” technology to monitor markets in real-time and process data incredibly quickly. It also promises strong security, is EU regulated with strict compliance standards, and is accessible on any device. Popular alternatives to ArbiSmart include Cryptohopper and Pionex.

References

• What is arbitrage
• Crypto arbitrage
• Crypto arbitrage trading how to make low risk gains