4min read
Published on: Mar 25, 2024
#Blockchain
#Trading 101
Have you ever met a crypto trader who constantly monitors different exchanges, intently looking at the price of various cryptocurrencies like ETH, BTC, SOL, XRP, etc, and exploiting their price differences for gain?
If your answer was yes, this means you have met a crypto arbitrageur.
In this article, we will unravel the meaning of arbitrage trading, especially in crypto, and how traders leverage this trading strategy to make profits.
Imagine a merchant who purchased gold for $100 in a certain location, and travels with this gold to another location where gold is scarce and sold at a higher price.
This merchant realising the massive profits he stands to make, immediately sells the same gold for $200. After this sale, he realises that he made back his cost price of $100 and a good profit of $100. Now that is arbitrage trading.
Arbitrage trading is as old as man, and it's done in every market, not just the financial market.
Arbitrage trading is a simple strategy whereby traders buy an asset or commodity at a lower price in one market and immediately sell it at a higher price in another market, making a profit on that asset.
Traders involved in arbitrage trading (aka arbitrageurs) take advantage of the price differences of an asset in different markets to make gains.
Today, crypto arbitrage has become one of the sweetest ways crypto traders can make money. This trading strategy works the same way the good’ol arbitrage trading works.
In crypto arbitrage, traders purchase a cryptocurrency or token in one market or exchange and immediately sell it in another exchange at a higher price for profit.
Here is an example of crypto arbitrage trading: A trader is logged on to Binance and BitDelta simultaneously and notices that the price of Bitcoin on Binance is $30,200; meanwhile BitDelta’s price is $30,500.
The trader immediately buys Bitcoin at that price on Binance and sells it almost directly at $30,500 on BitDelta, thereby making a profit of $300.
The profit might be small for some traders, but imagine it being done with large crypto amounts - the payoff would be huge.
Crypto Arbitrageurs capitalise on price and time differences across various asset markets to make profits.
They swiftly buy an asset at a lesser price in one market and simultaneously sell it at a higher price in another, profiting from the temporary inefficiencies.
By doing this, they maintain market efficiency by aligning prices and aiding accurate price discovery.
If you want to understand how crypto arbitrage trading works, you first need to understand that at certain times, different exchanges can have various cryptocurrencies listed on their exchanges at different prices.
Due to the volatile nature of cryptocurrencies, and the millions of transactions done in the market almost at the same time on various blockchain platforms and exchanges, prices fluctuate constantly.
This creates opportunities where the prices of various cryptocurrencies are different, and Arbitrageurs then leverage these opportunities to make profits.
While this trading strategy might look very simple, it can lead to losses if you lack an understanding of the basics and how various exchanges calculate cryptocurrency pricing.
Here is how crypto arbitrage trading works:
Differences in the Price of a Cryptocurrency
Crypto prices vary across platforms due to factors like supply, demand, trading volumes on blockchain, and regional influences. This creates openings for traders to capitalise on the price differences.
Buying Low, Selling High
Traders buy on a cheaper exchange and at once sell on a highly-priced exchange, reaping gains from these swift oscillations.
Speed is the name of the game, and traders who use this trading strategy have trained their fingers to work fast on the exchange to make a profit.
The following steps can be followed to start trading arbitrage:
Learn the Basics
Understand the concept of arbitrage and how it works. It involves leveraging price differences to make profits.
Identify Opportunities
Monitor different marketplaces and exchanges for assets with differing prices. Look for differences in the price of various high-value cryptocurrencies that you can exploit.
Speed
Arbitrage opportunities are very time-bound and fleeting. To capitalise, act swiftly. Consider setting up automated systems for prompt execution.
Consider Trading Fees and Exchange Costs
Be aware of transaction costs and taxes. Factoring in these expenses ensures accurate profit estimates.
Expertise is Key
Arbitrage requires skill. Be well-versed in the market, technologies, and strategies for effective execution.
Immerse yourselves in a trading community like ours at BitDelta to learn innovative arbitrage trading tactics from skilled and experienced arbitrageurs.
Risk Management
Risk management is essential in trading crypto because of how volatile the crypto market can be.
An inexperienced trader can allocate his money in crypto trading, and then lose it all due to upswings and downswings of the markets. The market volatility and instability can often be a threat to newer traders, hence why planning your approach accordingly is key.
Start Small
While it’s easy to get excited about launching your trading journey, it’s also essential to start with a modest capital. As you gain experience and confidence, you can scale up your trades.
There are different types of arbitrage trading in crypto:
1. Spatial Arbitrage
Also known as geographical arbitrage, it is arbitrage's simplest form, leveraging price gaps across distant markets.
Spatial arbitrage allows traders to buy crypto on one exchange and sell it higher on another. Nonetheless, costs, transfer times, and spreads impact profitability.
Example: A trader can purchase 1 BTC at $48,000 on Binance, and almost immediately sells it on BitDelta for $48,800. The trader makes a quick profit of $800 just before Binance adjusts the price of BTC to that of BitDelta or more.
2. Triangular Arbitrage
This is a popular type of arbitrage trading where crypto arbitrage traders leverage the price differences between three different cryptocurrencies.
Here’s an example of how it works:
A trader can spot a money-making opportunity between high-value coins like BTC, ETH, and SOL. They can notice that two are underpriced in a marketplace, and the other is priced the same across all exchanges.
So, the trader can start by trading their BTC for ETH, buying SOL with ETH for profit, and then converting that SOL back to BTC for profit.
3. CEX and DEX Arbitrage
This type of arbitrage involves leveraging market disparities between Centralised Exchanges (CEXs) and Decentralised Exchanges (DEXs).
It entails buying in one market and selling in another, capitalising on the price difference.
Here is an example: You can buy 1 Sol on a CEX like BitDelta for $100, and immediately sell it on a DEX like DYDX for $105. Thereby making a gain of $5.
4. Flash Loan Arbitrage
This is a more complicated type of arbitrage trading which seeks to leverage the flash loans to make a profit. It is reserved solely for advanced arbitrageurs.
Flash loans are no collateral-involved loans, which are very popular in the crypto space and bound by a smart contract.
For a flash loan to be used, a smart contract stating the terms and conditions of the loan is generated by the lender.
A crypto arbitrageur can take advantage of a flash loan by proving they can generate profit immediately if executed. The trader can structure various flash loans with the help of automated bots to create profits from arbitrage.
Example: A crypto trader spots an opportunity to earn a massive profit when he notices that ETH is traded for $2500 on one exchange and for $2550 on another.
This trader can use smart contracts to take out a flash loan of $10,000 worth of the cryptocurrency on the first exchange, sell it for $20,000 on the second exchange, then move ahead to repay the loan, and pocket the extra $10,000 as profit.
Benefits
Arbitrage offers lower-risk opportunities due to market neutrality, limiting long-term risk.
Traders exploit price differences in various markets, yielding profits.
Arbitrage enhances market efficiency by aligning securities' prices across markets.
Risks
Overlooking transaction costs and taxes can lead to profit miscalculations and losses. Research various exchanges first, before carrying out your arbitrage trade.
Very few arbitrage chances exist due to the continuous use of highly automated arbitrage bots, so newbies stand little to no chance to leverage this opportunity.
Crypto arbitrage trading demands substantial capital for successful execution. No crypto, no arbitrage trade.
Yes, arbitrage trading is profitable.
However, factors like transaction costs, rapid market changes, and the need for substantial capital can heavily affect profitability.
Understanding risks is essential before pursuing arbitrage.
If you are a new-time trader seeking to leverage arbitrage trading, you should know that this form of trading requires patience, constant learning, and lots of speed to succeed.
All in all, Arbitrage trading is a long-standing form of trading in the financial market and is done by most seasoned traders alongside spot trading.
You can start arbitrage trading on the BitDelta Exchange by signing up to the platform today.
This article is for informational purposes only and not intended as investment or financial advice. It contains opinions and speculations that are subject to change without notice.
The author and publisher disclaim any liability for decisions made based on the content of this article. Readers are advised to conduct their own research and consult a financial advisor before making investment decisions.
Join the community to receive exclusive market analysis and updates!
Ignite your financial journey with BitDelta's diverse asset classes.
