Only a few days are left before Coinbase goes for listing, and the crypto-community is now eager to know not only how the exchange...
In this guide, you’ll learn all ins and outs of arbitrage trading, see how it’s implemented in the crypto industry and find out if this trading technique is worth the effort at all.
Arbitrage is a trading technique exploiting price differences of a single asset between various exchanges and independent brokers, since each exchange has a slightly different supply/demand ratio.
The difference in prices is often found between local exchanges, which is tied to the economic situation in the countries where the exchanges are based.
Exchanges also have different processing capacities, meaning that smaller exchanges will often be lagging behind larger ones, creating additional opportunities for profit.
The ultimate difference between crypto and traditional markets, the difference in volatility, comes into play here too, since the extreme volatility of the crypto market reliably produces price differences that can be used for profit.
Exchange Arbitrage. When a trader spots a price difference between exchanges, they may buy an asset at a cheaper price and sell it at the exchange where the price is higher. The mechanism also works the other way around.
However, many traders will be aware of the difference, making it an urgent matter, since the prices are quick to even out. In addition, service charges need to be taken into account, since the price difference is usually small enough.
That makes the profit margin extremely low and may not accommodate the extra commissions on the trades.
This type of arbitrage is further divided into spatial and cross-border that have the same procedure, but the cross-border one involves exchanges situated in different countries.
Triangular Arbitrage. This form of trading has the word triangular in its name since it’s easier to visualize the algorithm by cracking it down into three logical steps.
Thus, with triangular arbitrage, to net a profit while assuming low transaction costs, traders utilize a discrepancy between three foreign currencies, which occurs when exchange rates do not match up.
Exchange-Broker Arbitrage. During impulse movement, when the price difference of an asset between a broker and an exchange rises, the trader can simultaneously buy the asset on the exchange and sell at the broker, or vice versa.
Once the price difference is back to the normal value, the profitable trade value is higher than that of the loss trade, yielding an overall profit.
Statistical. Some traders use sophisticated software that automatically tracks the price differences across exchanges. This software can provide profit opportunities that are precisely timed, which, on the one hand, widens the possibilities for the trader. On the other hand, it is associated with high risk due to the precision required for profitable trades.
Arbitrage has the undeniable potential for profit, is accessible to most traders and can be scaled up efficiently. However, to make a steady profit from arbitrage, the trader must be constantly monitoring the exchanges as well as the market situation in general.
As with any trading, the competition is high, so one must not only identify an opportunity but also use it before the price difference is evened out. Because of this, traditional arbitrage in the crypto market may become obsolete, but can still be done for now with the correct software and skills.
Low initial investment makes it even more difficult to extract profit because one must also pay attention to commission values to make sure that the trade is profitable.
Some coins will also have low liquidity, making it difficult to conduct simultaneous trades necessary for arbitrage, especially given the fact that multiple traders will likely be attempting to do so.
Despite the challenges, arbitrage remains a popular strategy in the crypto market, with new peer-to-peer services being created to connect traders from different countries for easier cross-border trades.
About the author: Julia Gerstein, a crypto trading bots enthusiast and a content writer at TradeSanta. My final goal is to help readers find what they need, understand what they find, and use what they understand appropriately.