The volatile nature, or dynamism, of the cryptocurrency market makes it as attractive as it is risky for traders. Arbitrage is one way to overcome that and even to use it to one’s advantage.
One word might well describe the crypto ecosystem: dynamism. True to the sector’s youthful nature too, change resulting in the volatility of different digital assets is the order of the day. Due to this volatility, both within and across exchanges lies the opportunity for cryptocurrency arbitrage.
So what is cryptocurrency arbitrage? How does it function and how can you make crypto arbitrage work for you? This article provides an in-depth view of this exciting crypto trading technique showing you how best to optimize your trading strategy.
What Is Cryptocurrency Arbitrage?
Crypto arbitrage is a trading technique that investors use to make profits by buying cryptos on an exchange and selling them on another. Alternatively, they may use the differences in prices of specific crypto trading pairs to trade them for gain.
Let’s look at a hypothetical example. Say exchange A lists Bitcoin (BTC) at $33,715, and at the same time exchange B lists it at $33,700, then an arbitrage opportunity has presented itself. You can buy the BTC from exchange B cheaply to sell it on exchange A for a profit of $15.
Although common in traditional stock market trading, many in the crypto space are just warming up to arbitrage.
What Are the Different Types of Crypto Arbitrage?
Now with a definition of what crypto arbitrage is, let’s shift our attention to the different strategies you may use to complete your trading.
Here you take advantage of the price differences between two different exchanges. You’ll buy an asset at a lower price from one crypto exchange and trade it for higher on another.
Triangular arbitrage occurs on the same exchange and involves price differences between crypto trading pairs.
For example, if you find an arbitrage opportunity among Bitcoin, Tether (USDT) and Ethereum (ETH), you could trade BTC for USDT first, then exchange USDT for ETH. And to make a profit, trade ETH back to BTC.
This approach takes advantage of a coin’s undervaluation on one exchange and its overvaluation on another. As a trader, you bank on the prices converging at some point. So you’d buy the asset when undervalued on one exchange and short sell it to another that’s overvaluing it.
Traders using this strategy perform arbitrage across decentralized exchanges (DEX).
Statistical arbitrage is an advanced form of crypto arbitrage where you use crypto trading bots and data models. The bots allow you to carry out many trades in a short time.
How to Optimize Your Crypto Arbitrage Strategy?
Identifying an arbitrage strategy is one thing, but making it work for you is another. To be in a position to reap benefits from crypto arbitrage, here are some pointers to boost your strategy:
Understand that cryptos are volatile
Keep in mind that digital assets are volatile. The market could shift in a split second for several reasons, including anything from a simple tweet from a recognized entrepreneur to government crackdowns on crypto-related activities. And yet that volatility is where the arbitrage opportunity can be found.
Optimize the speed of your trades
Speed is critical to successful arbitrage. Always be ready to seize on the windows of opportunity to make profits that open up to you. One way of doing that is choosing highly liquid exchanges, which help to instantly match and execute your orders. Low liquidity exchanges require more time, and by then, you’d have long lost the arbitrage opportunity.
Keeping up with the pace of transactions can be a big ask, but luckily bots can help. Besides automating your trades, they have built-in tools that track, analyze and optimize trading strategy.
Keep transaction fees low
Fees impact your profit. So to get the best out of crypto arbitrage, you’d want to cut out as many fees as possible. You can do this by depositing enough amounts of the cryptos you want to trade on different exchanges. Should an arbitrage opportunity arise, you can reshuffle your holdings to capitalize on it.
Be sure of your exchange’s security
Hot wallets used for crypto arbitrage are provided on exchanges, which themselves may be vulnerable to exploits. It is best, therefore, to trade on reputable crypto exchanges that can better ensure higher trading security.
Do your research
As is the case with all crypto investments, do your research. Be sure of what you’re getting into before committing your funds. While crypto arbitrage can open up opportunities for profit, investing solely based on luck can lead to a mistake that might cost you significantly.
Stick to liquid pairs only
Illiquid tokens and coins hinder a successful crypto arbitrage strategy. They may be popular owing to their significant disparities in quotations on different exchanges. Nevertheless, they may lack market depth, thus inhibiting trades. You won’t experience this problem arbitraging with liquid pairs, such as BTC, ETH, or Ripple (XRP).
What Are The Pros and Cons of Crypto Arbitrage?
No doubt, crypto arbitrage has its upsides and downsides. It all depends on how accurately you identify, calculate and execute arbitrage opportunities. So what are some of the positives presented by arbitrages?
- Creating opportunities to take quick profits and grow your investments faster
- Providing a wide range of trading possibilities
- Contributing to an exchange’s liquidity through trading fees
On the flip side, crypto arbitrages have the following disadvantages:
- A sharp market movement can ruin opportunities to profit
- All the transactions incur fees that eat into potential profits
- In the case of cross-border arbitrage, strict KYC requirements hinder the easy trading
Crypto trading strategies come as varied as the types of users. Crypto arbitrage is among those particularly gaining popularity. It enables trading on the price differences of a digital asset across two exchanges. You buy it at a lower price on one and trade it higher on the other. Again you may opt to trade two crypto pairs listed on the same exchange.
To realize the advantages of this strategy, you need to optimize your transactions. Other than choosing a faster and more secure exchange, you could incorporate trading bots. Furthermore, you should invest in liquid tokens and coins only, and by conducting thorough research. Amid market volatility, crypto arbitrage can create opportunities for fast profits, even if the risks can be just as steep if improperly executed.
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Note: BTSE Blog contents are intended solely to provide varying insights and perspectives. Unless otherwise noted, they do not represent the views of BTSE and should in no way be treated as investment advice. Markets are volatile, and trading brings rewards and risks. Trade with caution.