What Is Arbitrage in Crypto? How to Get Started

Crypto arbitrage trading is an investment strategy that attempts to take advantage of price differences across cryptocurrency markets for easy profit. The price of Bitcoin and other digital assets is not centrally controlled. This means that the price of Bitcoin could be, say, $103,600 on one platform and $103,650 on another. These price discrepancies often last for just seconds, but they can be profitable opportunities for traders who can arrange near-simultaneous transactions.

This article dives into the concept of arbitrage and how it’s used in various industries, and  thendetail all of the most popular crypto arbitrage strategies in use today.

What Is Arbitrage?

Arbitrage is the practice of buying and selling assets in different markets to take advantage of price differences. The term is used rather loosely, but for a transaction to qualify as “true arbitrage,” it usually has to meet the following conditions:

• Price discrepancy between two or more markets for the same (or an equivalent) asset
• Simultaneous or near-simultaneous execution of the buy and sell orders
• Minimal or no risk involved
• Guaranteed or nearly guaranteed profit

Arbitrage is a common strategy in lots of industries. Here are four of the most common examples.

1. Arbitrage in Retail

Retail arbitrage refers to the strategy of purchasing products at a lower price from one retail market and reselling them for a profit in another. For example, if an antique table sells for $10 at a car boot sale and $15 on eBay, one could buy it at the sale and sell it on eBay for a $5 profit. Many ecommerce stores source products from China, where they are made cheaply, and sell them in the US or Europe.

While this strategy is commonly called retail arbitrage, it doesn’t exactly fit the definition of true arbitrage as it involves significant risk (what happens if it doesn’t sell?), time delays, and market variation.

2. Arbitrage in Finance

Financial institutions like hedge funds and investment banks use arbitrage to trade assets like stocks, bonds, commodities (like gold and oil), and forex all the time. For example, a public company could be listed on both the New York and London stock exchanges with a slightly different stock price in the two markets.

Forex trading is another example. If €1 is worth $1.12 and £0.84, you could buy $10,000 worth of Euros and use them to buy $10,125 worth of Pounds.

Price differences in these markets tend to be tiny, but investors can profit by trading at scale. However, improvements in technology, along with the massive competition from other arbitrageurs, mean that price differences in popular assets are far less common than they once were and they may only last for milliseconds. As a result, there are fewer and smaller opportunities for arbitrage in finance, though there are plenty of exceptions, namely crypto.

3. Labor Arbitrage

Many companies take advantage of lower labor costs in other markets. For example, companies operating in the UK regularly set up call centers in India to deal with their customer service needs.

4. Arbitrage in Events

Arbitrage in event ticketing is likely one of the least popular forms of arbitrage, and yet it’s already widespread. Ticket scalpers or touts buy tickets for concerts or sports events at face value and resell them on secondary markets at a higher price.

Advantages of Crypto Arbitrage

Crypto arbitrage is generally considered a low-risk investment strategy. Unlike many investment strategies, it is not based on predictions about the future price of an asset but rather on known variables. However, it is important to be aware that crypto arbitrage trading is not risk-free.

Crypto arbitrage is also a relatively accessible investment opportunity. The volatility of crypto markets means that there are frequent opportunities for profit if you know what you’re doing and have a large enough bankroll.

Crypto markets operate 24/7 and are accessible anywhere in the world. Once an opportunity is identified, returns can be immediate. Some crypto arbitrage trading strategies are also beginner-friendly, and automated bots can do most of the work. However, crypto arbitrage trading does require a level of skill and knowledge.

Disadvantages of Crypto Arbitrage

Arbitrage opportunities can (and often do) vanish in less than a second. Trading with this strategy requires constant monitoring and lightning-fast trading. Automated bots make this easier but they generally come at a cost.

There is also a risk that prices can change while a deal is in motion, resulting in a loss. When blockchain networks experience congestion, transactions can be delayed by minutes or longer, and cryptocurrency exchanges are sometimes slow to process withdrawals. While you’re waiting, you can miss your trade window.

Crypto arbitrage also generally requires multiple accounts set up on different exchanges and wallets. This can be a hassle to manage. On top of that, buying on one platform and selling on another means paying transaction fees for both platforms – which eats into profits. When blockchain networks are congested, transaction fees (i.e. gas fees) can be prohibitive.

Finally, while there are currently plenty of opportunities for crypto arbitrage trading, the market will undoubtedly become more efficient over time, as we’ve seen in traditional financial markets. This means fewer price discrepancies and shorter windows of opportunities. Automation tools have improved and more traders are scanning for price discrepancies which makes this space more competitive.

Crypto Arbitrage Strategies

There are various strategies for taking advantage of price discrepancies in crypto. Here are some of the most popular:

1. Cross-Exchange Arbitrage

A crypto exchange is a platform where people can buy and sell cryptocurrencies and related assets. Cross-exchange arbitrage (aka simple arbitrage) involves buying a cryptocurrency on one exchange and selling it on another at a higher price. For example, you could buy 1 ETH on Binance for $2,000 and sell it on Coinbase for $2,010.

Speed is key for this strategy as you’re fighting against thousands of bots and fast arbitrageurs. Traders often use bots to identify price differences and often hold various currencies on multiple platforms to speed up transactions. Cross-exchange arbitrage is the most common crypto arbitrage trading strategy.

Decentralized Exchange Arbitrage

A subset of cross-exchange arbitrage is decentralized arbitrage. This is when traders take advantage of a price discrepancy between a centralized exchange and a decentralized exchange (or DEX) or even between two DEXs.

Centralized exchanges, like Coinbase, Binance, and Kraken, are regulated businesses owned by a single group or entity while DEXs, like Uniswap and Sushiswap, are peer-to-peer marketplaces. DEXs operate differently from centralized exchanges which can result in more (and larger) price discrepancies, which is why it’s a popular strategy for arbitrageurs.

2. Cross-Chain Arbitrage

Cross-chain arbitrage is similar to cross-exchange arbitrage, but it exploits differences across blockchains rather than exchanges. For example, you could buy 1 USDT on Ethereum for $1 and sell it on Polygon for $1.02. In order to do this effectively and profitably, you would likely need to hold large sums of tokens on multiple different blockchains, requiring a crypto bridge. Bridging tokens can be slow, and there is a risk of slippage. While crypto exchanges are user-friendly and accessible, trading directly on the blockchain often requires more experience.

3. Triangular Arbitrage

Triangular arbitrage takes advantage of price discrepancies across three cryptocurrencies, usually on the same exchange. Let’s use these fictional exchange rates for an example.

• 1 Bitcoin = 10 Ether
• 1 Ether = 2.5 Tether
• 1 Bitcoin = 20 Tether

You can trade 1 Bitcoin for 10 Ether and 10 Ether for 25 Tether. You can then trade the 25 Tether for 1.25 Bitcoin. This means you made a profit of 0.25 Bitcoin, minus any fees. Naturally, the discrepancies you will see in the real market will be vastly smaller in most cases, but there is still quite a bit of potential in this strategy.

The advantage of trading on a single platform is that you lower the risk of delay and pay fewer fees.

4. Spatial Arbitrage

Spatial arbitrage takes advantage of price differences across different regions. For example, if an exchange opened up in a country which previously banned crypto exchanges, there could be a surge in demand which would push up prices. Spatial arbitrage traders need to be aware of restrictions on moving assets in and out of the region as well as tax and other regulatory issues and also be wary of delays.

5. Statistical Arbitrage

Statistical arbitrage is not for beginners, and it’s another example of a strategy that is dubbed arbitrage but doesn’t really fit the true definition. It often uses algorithms and historical data to anticipate price changes across crypto assets.

These strategies generally involve placing both long and short positions to try to profit from small pricing discrepancies. Statistical arbitrage requires more capital and technical know-how than the others and is a high-risk trading strategy, even for the experts.

Crypto Arbitrage Automation Tools

Arbitrage opportunities are fleeting, and it is very difficult (and often impossible) to manually execute a trade before the window of opportunity closes. As a result, traders use automated bots that can execute trades in under a second. Platforms like Cryptohopper, Coinrule, Bitsgap, and Pionex constantly monitor hundreds of exchanges and execute trades automatically when an opportunity appears.

These tools are generally no-code, meaning that users do not need to know how to code to use their features. However, they often come at a price. Cryptohopper’s products, for example, range from a free version to a $107.50/month version, while Pionex charges a 10% fee on profits. Coinrule also offers a free product, but its most expensive product is a whopping $749/month. Free arbitrage bots are likely less sophisticated and successful than others.

While you’re investigating tools for trading, take a look at price scanning websites, like CoinGecko and CoinMarketCap, crypto trading APIs, and latency reduction measures.

What Are the Risks of Crypto Arbitrage Trading?

Even though arbitrage typically comes with fewer and smaller risks than regular trading, it’s far from risk-free, especially for beginners. Here are some of the main risks you need to be aware of:

1. Slippage

One of the main risks of crypto arbitrage trading is price slippage. Slippage is when the expected price of a trade and the actual price at which it is executed are different. One cause of slippage is market volatility. Crypto arbitrage traders can incur losses if the price of an asset suddenly changes before a deal is complete.

Another cause of slippage is low liquidity. Liquidity is a measure of the ease with which a digital asset can be converted into another asset, such as Bitcoin or cash. Liquidity helps to keep the market stable. Lower liquidity can create arbitrage opportunities, but it can also cause slippage, which can lead to losses. Make sure to check the liquidity of any exchange pair or pool before you dive in, as slippage in crypto can eat up your profits fast.

2. Delays

Some cryptocurrency exchanges are slower than others when it comes to transactions and withdrawals. Blockchain network congestion can also delay transactions. These and other technical issues can cause losses if the price changes before the trade is executed.

3. Regulation

Cryptocurrency regulations vary by jurisdiction, and policies may change unexpectedly. For example, it is a good idea to check the tax implications of crypto arbitrage trading activity in your region.

4. Market Instability

Mark instability is a major risk for all crypto traders. Many parts of the crypto industry are unregulated, and some assets function in experimental ways with limited oversight. The example of TerraUSD and Luna is one of many cautionary tales.

The Terra USD stablecoin and it’s sister token Luna were tied together using a complex algorithm that incentivized arbitrage traders to balance their prices out. However, in May 2022, hundreds of millions of dollars worth of UST was sold at once, totally destroying the system. The price of UST (which was supposed to maintain a near-constant value of $1) crashed and it ultimately become worthless.

Arbitrage traders with large amounts invested in Luna and TerraUSD experienced massive losses. This is a reminder that crypto markets are volatile, and even so-called stablecoins are not necessarily stable.

How to Get Started With Crypto Arbitrage

If you’re thinking of giving crypto arbitrage trading a try, here are some basic steps to help you get started.

Step 1: Choose a Strategy

It makes sense to start with a simple, low-risk strategy like basic cross-exchange arbitrage. Do your research on the strategy and the risks involved and spend some time studying the market.

Step 2: Set Up Accounts

For cross-chain arbitrage strategies, you’ll likely need accounts on several cryptocurrency exchanges such as Coinbase, Kraken, KuCoin, Gemini, or Binance. It’s often best to choose a regulated, beginner-friendly exchange with good liquidity, competitive fees, and speedy transaction times. You can conduct a few small trades to practice or even use paper trading tools to test strategies without risking real money.

Before you dive in headfirst, start watching for price discrepancies and consider the platforms’ transaction fees and times. You should also consider storing capital on multiple exchanges for easy access, as it would likely take too long to transfer between exchanges after a discrepancy arises.

Step 3: Identify Opportunities

Once you’re ready to get started, monitor prices to spot opportunities. You can use websites like CoinGecko, TradingView, or CoinMarketCap to do this manually or try out an automated tool. You may find more opportunities in more obscure places, but remember to factor in fees, security measures, and potential slippage when assessing potential profits.

Step 4: Act Fast

Once you see an opportunity, you will likely have to move quickly to execute the trade. Again, this can be done manually or using a bot, though you may find that manual trading is much too slow. Remember that you can always start small (or even paper trade) and increase your trading capital down the line as you become more experienced to decrease your risk of a major loss.

Is Crypto Arbitrage Still Worth It?

Crypto arbitrage can be relatively low risk if you do it right, especially in comparison to some other crypto investment strategies. Even beginner traders can use tools like automated bots to identify opportunities and execute trades. However, there are a variety of risks associated with crypto arbitrage, including market instability and slippage, and some crypto arbitrage strategies are riskier than others. This space has also become very competitive, but traders with enough capital and the right tools and skills can still profit from crypto arbitrage trading.

FAQs

References

1. Cross-Chain Arbitrage: Web3 Explained – Uniblock
2. Crypto Arbitrage: What Is Crypto Arbitrage & How Can You Profit? – Gemini
3. How a Trash-Talking Crypto Founder Caused a $40 Billion Crash – NYT
4. Trading and Arbitrage in Crypto Markets – MIT
5. What happened with Terra (LUNA), and can it happen again? – Rutgers Business School
6. What Is Arbitrage? 3 Strategies to Know – Harvard Business School
7. What Is Crypto Arbitrage? How Does It Work? – Forbes
8. What Is Crypto Arbitrage Trading – Coinbase
9. What is Crypto Arbitrage Trading & How Do Traders Use It? – Moonpay
10. What is slippage in crypto and how to minimize its impact?- Coinbase