Crypto Arbitrage Trading Guide: How to Make Low-Risk Profits

If you are new to the cryptocurrency space and you don’t know how to day-trade due to the technical analysis that follows, then crypto arbitrage trading could be a good start for you as it is a less risky trading strategy.

With billions of dollars’ worth of cryptocurrency being transacted every day in the cryptocurrency market, there is some discrepancy in the pricing of the cryptocurrency assets across different exchanges, which paves the way for crypto arbitrage trading.

In theory, the price of any cryptocurrency asset should be the same across different cryptocurrency exchanges, and this is contrary to what is seen today. So what crypto arbitrage traders do is take advantage of this discrepancy in the price of these coins and make some profits.

In this post, I will be introducing you to what crypto arbitrage trading is, how you can make money with it, and what associated risks exist.

What Is Crypto Arbitrage Trading?

Crypto arbitrage trading is the process of buying a cryptocurrency asset at one exchange and simultaneously (immediately) selling it at another exchange at a higher price.

Arbitrage trading is just like normal cryptocurrency trading, where the goal is either to “buy low and sell high” or “sell high and buy low”. The only difference is that instead of doing this for price changes on a particular exchange, it is done rapidly for price discrepancy across different exchanges or across different crypto asset .

Speed is very important in crypto arbitrage trading. This is because the price differences that pop across these exchanges usually don’t take a long time to normalize, so any crypto arbitrage traders must be able to perform fast transactions in order to benefit from it. If you are not conversant with placing the different order types, you can check out our guide on limit order and stop limit order

Here is an example of Crypto arbitrage trading:

On Bybit, the market price of Solana coin might be $108 and, at the same time, its market price might be $100 on Binance, which is a price difference of $8. Traders who can trade this price differences will make a lot of money, especially if they use a large amount of money to do that.

Reasons For Crypto Arbitrage Opportunity:

There are many reason why there are some discrepancy in the price of a crypto asset across different exchange. Popular ones are:

• Supply and demand are not consistent.
• Differences in the liquidity of a particular coin on different exchanges.
• Difference in the time spent on deposit and withdrawal of an asset across exchanges.
• Difference in crypto-to-fiat exchange rates.

Types of Crypto Arbitrage Trading

Although crypto arbitrage trading literally means leveraging the cryptocurrency price discrepancies, there are many ways in which they are done and this is used in classifying them into different types.

Here’s a summary of the types of crypto arbitrage trading:

1. Exchange arbitrage: Buying coins at a lower price on one exchange and immediately selling them higher on another.
2. Triangular arbitrage: Taking advantage of cross crypto price differences  within an exchange.
3. DeFi arbitrage: Taking Advantage of the Discrepancy in the Percent Yields or rate of swap Offered by DeFi Lending Protocols.

Exchange arbitrage.

Exchange arbitrage trading is the act of buying a cryptocurrency asset on one exchange and selling it immediately on another exchange when a price discrepancy in price is noticed.

Due to the difference in liquidity of assets on different exchanges, the price of such assets will tend to fluctuate differently on each of these exchanges, creating a discrepancy in price. Exchange arbitrage traders take notice of these differences in prices and leverage them by buying on one exchange and selling on another exchanges.

Here is an example of exchange arbitrage trading.

Observing the price of bitcoin overtime, a trader may notice it trading at $40000 on Binance and $39900 on Bybit at the same time. He will then benefit from it by buying it on Bybit and rapidly selling it on Binance. Although transaction charges need to be removed, such a trade will result in a profit of $98 or more per unit of bitcoin.

Challenges In Exchange Arbitrage Trading.

Although exchange arbitrage trading can be profitable when done correctly, there are some challenges that follow that, if not watched, will result in huge losses. Here are some of the popular challenges in exchange arbitrage:

• Rapid price movement.
• High Cross Exchange Gas fees
• Delay  in transaction do to User authentications.
• Slippage.

Triangular arbitrage.

Triangular arbitrage is the process of buying and selling cryptocurrency within an exchange when a price discrepancy is noticed between two crypto pairs made up of three different coins, and exchanging them with one another in a loop.

Here is how triangular arbitrage works:

Upon noticing an undervalued coin among BNB, USDT, and Ethereum, a trader can profit by using his USDT to buy BNB, then using the BNB to buy Ethereum, and then selling the Ethereum back to USDT.

At the end, the amount of USDT such traders have must be greater than what they had at the start for such a trade to be termed profitable.

Unlike exchange arbitrage, triangular arbitrage opportunities can be very difficult to spot, but once they are spotted, they can be very profitable as there is no much transaction fee since they are within an exchange.

Challenges In Triangular Arbitrage Trading.

• Arbitrage opportunity can be difficult to spot.
• Crypto prices can move too fast.
• Price slippage.
• Gas fees Can cut into profit.
• Usually takes 3 or more transaction to complete a trade.

 

DeFi Arbitrage.

Decentralized finance, also known as DeFi, is a non-intermediary exchange platform where traders can swap their coins, or lend it to the platform in other  to earn some interest.

Here, there is no human intervention; it is an automated exchange with different pools that allows users to swap their coins.

On swapping those coins, such traders pay some transaction fees, and these fees are used to pay liquidity providers (those who lend their coins) on the platform.

DeFi arbitrage is the act of taking advantage of discrepancies in liquidity pools holding the same assets or in the percentage yield offered by DeFi Lending Protocols. In any liquidity pool, a particular coin is paired with another one and anybody can swap their coin on this pair.

Here is an example of DeFi arbitrage:

Consider the following liquidity pools in Uniswap:

1) ETH-USDT

2) USDT-USDC

3) USDC-ETH

Let’s say these coins are swapped in the following ways:

In pool 1, an ETH cost 3000 USDT, in pool 2, USDT=USDC, and in pool 3, an ETH cost 2000 USDC.

We can notice a price discrepancy between pools 1 and 3.

To leverage this variation, we trade as follows:

By swapping 1 ETH in pool 1, we get 3000 USDT. We then swap our USDT for USDC in a 1:1 ratio in pool 2, and finally swap our 3000 USDC in pool 3 for 1.5 ETH, gaining 0.5 ETH at the end.

To learn more about DeFi Arbitrage trading, you can check this page.

Challenges In DeFi Arbitrage Trading.

• Gas fees Can cut into profit.
• Usually takes 3 or more transaction to complete the trade
• The rate may change Before your trade is finalized

Concluding Thoughts.

When compared to other strategies of trading, crypto arbitrage trading is considered a low-risk endeavor.

For instance, unlike in normal day-trading, where a contract is entered for the price change of an asset, arbitrage trading allows you to hold the same asset and there is no form of contract for price change. Most of the losses seen in arbitrage trading are from transaction fees, and most of the time these losses are minimal.

However, the risk involved in this type of trading strategy should never be underestimated. These risks, when neglected, can cut into the capital of any trader, and you don’t want to be a victim of that. Therefore, on spotting any arbitrage opportunity, a trader must hasten to complete the transactions before the market normalizes.

Disclaimer:

As always, the information on this page is based on our experience and the research we have done. You can refer to our disclaimer page to know how you should treat information on this website.