The most common method of crypto trading is buying low and selling high. But what if I told you that you could generate good profits by taking advantage of price differences in the market? This means you buy a token from a market where it’s priced low and sell it on another at a higher price.
To better understand crypto arbitrage, I suggest you continue reading this guide. We will discuss how this trading strategy works and the various types of arbitrages.
What’s Crypto Arbitrage?
As already mentioned, crypto arbitrage involves spotting a price difference between two markets and capitalizing on it. Arbitrage can be conducted in two ways: Between two crypto exchanges or within a single exchange. The former is super simple. First, you need to select a crypto asset and identify price variations on the trading platforms where it is listed. After doing so, buy it cheaply from one platform and sell it high on another.
On the hand, performing arbitrage on one crypto exchange can be a little complicated. Famously known as triangular arbitrage, it involves profiting from price differences in three trading pairs. For example, if you own ETH, you can buy BTC with it and then buy, let’s say, BNB with the BTC and finally convert BNB back to ETH.
However, it is worth highlighting that these price differences rarely last for long. Therefore, losing money while carrying out crypto arbitrage is also possible.
Factors That Cause Crypto Arbitrage
Different Fiat currency rates: If, for example, EUR’s price is higher than USD’s, Arbitragers can profit by buying Bitcoin using USD and then selling it for EUR.
The difference in liquidity across various exchanges: High liquidity keeps the token’s price stable. But many small trading platforms lack enough liquidity, thus causing price fluctuations. This creates arbitrage opportunities.
Different types of exchanges: There are trading platforms designed with institutional investors in mind, while there are those developed for retail investors. Price gaps can always be identified between these two types of exchanges. Therefore, if a token on an exchange friendly to retail investors is trading for a low price, you can buy it there and then sell it on an institutional investors’ exchange.
Pros of Arbitrage Trading
Crypto arbitrage offers several advantages to traders. They include:
Low risk: arbitrage trading strategy is considered less risky than other trading methods because you’re purchasing and selling crypto simultaneously.
Profitable in both bull and bear markets: Crypto arbitrage opportunities can be found when the market is rallying or crashing.
Cons of Arbitrage Trading
Despite crypto arbitrage being a low-risk venture, it has some disadvantages you should be aware of. Here are some:
Transaction fees: Before performing an arbitrage, always check the trading and the gas fees to be incurred, as they might eat up all your profits.
Crypto exchanges’ risks: Arbitrage mainly occurs on centralized crypto trading platforms. This means you do not have total control over your assets. That said, you might lose your funds if the crypto exchange decides to close down abruptly.
Large capital investment: Unlike other trading strategies, crypto arbitrage requires traders to spend significant amounts of money to realize profits.
Regulations: As stated earlier, arbitrage happens on centralized exchanges regulated by various authorities. Therefore, you may miss arbitrage opportunities if you fail to provide information verifying your identity.
How to Spot a Crypto Arbitrage Opportunity
They are two ways of finding arbitrage opportunities. They include:
Using Software
With multiple cryptocurrencies in the market, monitoring them simultaneously can be challenging. That’s where software programs come in. They scan the market and present tokens with price differences to traders, who then execute trades. Moreover, there are software programs that perform arbitrage automatically for traders. Some of them include Pionex, CoinMetro, Trality, Bitsgap and Cryptohopper.
Finding Less Known Tokens
When a cryptocurrency is widely traded, the possibility of finding a price gap is shallow. Therefore, if you are looking for arbitrage opportunities, focus on less popular tokens with little trading activity.
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