With the popularity of cryptocurrency surging in recent months and years, a new wave of investors from millennials to baby boomers are experiencing FOMO and rushing into coins. Traders are exploring different avenues of earning profits from an industry that does not seem to rest. Among the different ways of trading crypto coins on an exchange is an old strategy often used in traditional markets known as crypto arbitrage. But what does the term cryptocurrency arbitrage mean and how do traders use this trading method to leverage market fluctuation in prices?
In this article, we will explore the background to crypto arbitrage, how arbitrage trading works, its pros and cons, common crypto arbitrage strategies including the use of automated bots to earn profits.
Crypto arbitrage is a term that is used to describe a strategy that benefits from different prices of the same asset that is trading on another exchange. In simpler terms, a trader can take advantage of small differences or imbalance in price valuation between an asset that is listed on 2 exchanges to generate a profit. For example, a person can buy an asset on the exchange for $100 and immediately sell it on the other exchange for $120 to profit the difference of $20 (minus any fees).
Arbitrage trading would not exist if prices of crypto assets were the same across all cryptocurrency exchanges. While the asset supply and market demand should result in a consistent price point, this is not always the case due to inefficiencies in the market. That is, the listed prices can vary due to each exchange's fees, spreads, trade volume and liquidity in the order book at any given time. One of a combination of these factors can result in subtle or significant changes to crypto prices on the exchange. For more information on the differences in prices, read this article that explains the impact of spread in crypto trading.
Due to market irregularities in prices across the most used crypto exchanges, individuals can take advantage by analyzing the bid and ask price across several exchanges to identify arbitrage opportunities. Arbitrage works by identifying a difference in the listed crypto price for a particular asset. Once identified, the person can buy the coin on the exchange at a cheaper price and instantly sell it for a profit on a different exchange with a higher price. If this strategy is repeated consistently over a period of time, a small profit can result in significant gains.
Crypto arbitrage trading works best using the larger exchanges to purchase the asset which can offer better prices (i.e. smaller spreads). The coin can then be transferred to lower volume exchanges where the spread can be higher due to low trading volumes. The increased difference between the bid and ask price can result in discrepancies in market value between the two exchanges.
An example of a well-known arbitrage incident occurred in 2017 between Kraken, a US crypto exchange and Bitstamp. At the time, the price of Bitcoin on Kraken was $17,212 compared to $16,979 on Bitstamp. Traders immediately took advantage of the difference in the listed price and bought Bitcoin on Bitstamp for $16,979. The coins were immediately transferred to Kraken and sold for a premium resulting in a profit of $233 per Bitcoin.
Finding arbitrage opportunities where there is an imbalance in crypto prices across different trading exchanges can be difficult. Traders can make money by purchasing a cryptocurrency on an exchange the offers the lowest price. If the asset can be transferred quickly to an exchange with a higher price and sold, it can be a profitable trading strategy in the long run. Several risks that can reduce profitability such as changes to price direction, sudden volatility, exchange fees and the time to transfer the coin to another exchange.
Pros of arbitrage trading
- It is a fairly low-risk crypto strategy for advanced traders if the opportunity is quickly identified and executed
- Using sophisticated computer programs ensures that market volatility can be tracked to maximize returns
- Automatic trading bots can be used across multiple exchanges to arbitrage trade crypto
- Helps to create a fair and efficient market across all exchanges when the price imbalances are identified
Here are some important points to consider to ensure a successful crypto arbitrage trade:
- Select a liquid trading asset. Arbitrage trading involves buying and selling at market price, the markets must have sizable order books to protect against slippage. A liquid crypto asset for example would be Bitcoin or Ethereum
- Monitor prices on multiple exchanges. This can either be on multiple exchanges or the same exchange with different currency pairs to identify price discrepancies. We recommend using a crypto charting package to monitor crypto prices such as TradingView or Coinigy which have the option of setting price alerts
- Have verified and funded accounts across several crypto trading platforms. Ensure the account is adequately funded to immediately execute a buy order when an opportunity presents. This can reduce the transaction time and limit deposit/withdrawal fees
- Whitelist and save the address. To reduce the time between buying and selling the asset on a different exchange, it is a good idea to save the deposit and withdrawal address on the two exchanges to hasten the transfer process
- Use portfolio management platforms with APIs. Exchanges such as Shrimpy and Quadency can be used to monitor prices across multiple platforms and automate orders using bots. For more information, read our article on the best charting software to analyze crypto.
- Consider the fees. Each cryptocurrency exchange has different fees for providing its services. Most platforms will have trading fees that apply to both buy and sell transactions. There is also the blockchain network fee charged by miners to validate the transaction. A good option is to use a crypto exchange with zero trading fees to increase profitability such as Phemex.
The two most common methods to perform crypto arbitrage between exchanges are between 2 exchanges (also known as “Spatial Arbitrage”) and between more than two exchanges (also known as ‘Triangular Arbitrage”).
Spatial arbitrage involves buying a crypto asset from one exchange at a higher price and selling it on another exchange that lists the same asset for a lower price. This is the most common method to profit from the price difference. The same principle is best applied between exchanges situated in two geographically separate countries such as a USA crypto exchange and a crypto platform in the UK.
An example of a spatial arbitrage trade is as follows.
- Purchase a crypto asset (e.g. Ethereum) on Exchange A with a higher price
- Transfer the Ethereum, to Exchange B with a lower price
- Sell the Ethereum on Exchange B and profit from the difference in price
The triangle arbitrage strategy is used to benefit from price differences between 3 assets when the exchanges prices do not accurately match. If the difference in the exchange prices is substantial, the trader can make a profit. Exchanges that list multiple pairings for cryptocurrency assets with fiat can increase the opportunities for triangular arbitrage.
An example of a triangular arbitrage trade is as follows.
- Purchase a crypto asset (e.g. Bitcoin)
- Trade the Bitcoin for a second asset (e.g. Ethereum)
- Trade the Ethereum for a third asset (e.g. Litecoin)
- Trade the Litecoin back to Bitcoin
Triangular arbitrage trading can also be performed using 3 crypto platforms that offer slightly different prices. However, it can become very difficult to manage trades, minimize fees and is not recommended for beginners.
Successfully implementing crypto arbitrage strategies can be difficult as the prices of an asset can change frequently to adjust to any market inefficiencies. It can be particularly challenging using the spatial or triangular arbitrage methods across multiple exchanges.
What Are Crypto Arbitrage Bots?
There are several tools available to traders that can automate the process of finding and trading arbitrage opportunities. Software developers have created tools such as “crypto arbitrage trading bots” that are purpose-designed and programmed to meet specific trading requirements and execute arbitrage opportunities. Automated crypto bots can be created, purchased, downloaded and implemented using popular crypto trading platforms.
How Do Cryptocurrency Arbitrage Bots Work?
Arbitrage bots are computer programs that are developed to automatically execute buy and sell orders to an exchange based on a predefined trading strategy. The crypto bot is linked to the exchange using an Application Programming Interface (API) to actively monitor the market and place orders when specific criteria that have been programmed are met.
What Are The Benefits of Using Arbitrage Bots?
Using a bot to automate arbitrage trading in the cryptocurrency market can offer the following benefits:
- Instant market and exchange analysis. Crypto trading bots can quickly gather and automate the interpretation of market data, pricing, technical indicators and statistics. The bots can be programmed to calculate the potential market risk of buying or selling cryptocurrency assets between different exchanges more efficiently than a human being.
- Trade multiple exchanges worldwide and 24/7. The cryptocurrency market never sleeps with exchanges operating 24*7, 365 days of the year. A crypto arbitrage trading bot can be programmed to arbitrate cryptocurrencies across multiple exchanges constantly and without human intervention.
- Execute trades near-instantly. Bots can work significantly faster than humans, giving rise to the concept of “High-Frequency Trading”, which makes it possible to capitalize on opportunities that exist for only a few seconds. Traders tend to favor the small, consistent profits gained this way since an amalgamation of small profits can result in a bigger pool of gains.
- Remove trading stress. Constantly searching for arbitrage opportunities and placing orders across various markets and exchanges can be a challenging task. Over-trading is a common reason traders lose money in crypto. A trading bot can be useful to remove the emotion out of trading which may increase profitability.
- Cut losses early. Crypto trading bots are programmed to make a decision based on data, trends and a pre-defined set of rules that can be implemented to manage trade risk. A bot will automatically cancel or exit a trade instantly if the criteria for an arbitrage opportunity are voided which can avoid potential losses.
Bitsgap has a single user-friendly interface that connects with over 25 exchanges such as Coinbase Pro, FTX Exchange, Gate.io, EXMO and others. Traders can work with 1000+ cryptocurrency pairs to make potential profits due to price imbalances. The bot will automatically buy crypto on an exchange where the price is lower and then sell it on an exchange where the price is higher. The bot is cloud-based and gives traders real-time insights related to the market.
Cryptohopper is aimed at making trading seamless for both novice and experienced traders. The crypto bot is quite popular for its seamless UI and trading resources. Moreover, it allows traders to explore price differences within an exchange and also between exchanges. Cryptohopper supports over 75 cryptocurrencies and is compatible with 14 exchanges like OKEx, Bittrex, Bitpanda and KuCoin.
Like the other examples above, traders can connect to multiple exchange accounts to analyze the best possible option for selling the crypto asset using Gimmer. The bots then transfer the asset between exchanges to earn a profit. Gimmer bots let the trader know about risks involved in certain exchanges. Gimmer is connected to 10 exchanges globally which are less than Coinhopper and Bitsgap, however, includes a back-testing tool to test an arbitrage trading strategy.
Pionex is one of the first crypto exchanges that offers in-built trading bots for the crypto market. There are in total 18 bots to choose from that includes martingale, grid trading, dollar cost averaging and others. Moreover, the fees are extremely competitive at 0.05% per trade with no additional costs to use the bots. For more information, read our detailed review on Pionex.
Is Crypto Arbitrage Trading Legal?
Cryptocurrency arbitrage is legal in many countries since it promotes market efficiency and price equalization. Traders are empowered to take full advantage of arbitrage opportunities and help to balance the price of an asset in multiple markets.
Which Exchanges Are Best for Crypto Arbitrage?
The main strategy with arbitrage is to buy an asset for a low price on an exchange to sell it for a profit on another exchange. Larger cryptocurrency exchanges such as Binance, Gemini and Huobi that have high trading volumes and liquidity will generally have lower spreads that can result in slightly cheaper market pricing. Arbitrage opportunities can exist in the crypto market by selling the asset on low liquidity exchanges that have less trading volume with higher spreads and slippage.
To conclude our article on arbitrage trading in the cryptocurrency market, finding and trading price differences between exchanges can be a profitable trading strategy for experienced users. However, the opportunities are becoming less and less with exchanges identifying gaps in asset values quicker and rectifying the price inefficiency. This means that any crypto arbitrage opportunities may only last for a matter of seconds or minutes.
Using an arbitrage crypto bot can be considered to quickly capitalize on crypto arbitrage opportunities on a single exchange or across multiple trading platforms. The bots can execute trades much faster which can increase potential profits in the long run. For beginners, a recommended way to start using arbitrage bots is to find a crypto platform with a demo platform that has in-built automatic bots. For a list of the best trading bots for crypto, read our comparison article to help choose the right crypto bot.
Kevin started in the cryptocurrency space in 2016 and began investing in Bitcoin before exclusively trading digital currencies on various brokers, exchanges and trading platforms. In 2019, he started HedgewithCrypto to publish informative guides about Bitcoin and share his experiences with using a variety of crypto exchanges around the world.