The Cryptocurrency industry is arguably the fastest-growing industry in the world right now. A lot of factors have contributed to this over time, some of which include its uniqueness, independence from centralized government controls and manipulations, its utility, which cuts across several sectors, the vast array of financial and business opportunities the industry has to offer to mention but a few as the list goes on.
However, the cryptocurrency space has limitations, shortcomings, and its fair share of negativities, one of which is the high-risk level and volatility of the crypto industry. This is where Crypto Arbitrage comes into play, as it is a way to navigate the cryptocurrency market/industry with very little risk level.
This article will discuss crypto arbitrage, helping you understand the term properly while explaining how it can be implemented in the cryptocurrency market, mitigating or minimizing the risk level.
What is Crypto Arbitrage
Crypto arbitrage is an investment strategy that capitalizes on the price difference in cryptocurrency. Let’s start with the classic arbitrage definition before moving on to crypto arbitrage.
Arbitrage trading is when a trader purchases and then sells the same product on several different marketplaces in order to make a profit. Arbitrage tactics are used in footwear, for example. A trader may buy a pair of Air Jordan for $200 on one website and immediately sell them for $225 on another website. The difference of $25 is paid to the trader. A “thrift store” may mark an item at a low price, but the item could command a high premium on a vintage market.
The most important thing to remember is that someone is always looking to profit from the disparity between prices of similar items on different markets. This trading strategy is not limited to crypto assets, as shown in the above examples, but across any market where buying and selling are involved.
You must understand that crypto assets are valued differently by different exchanges, and the processes used to determine those prices may also differ. Arbitrage traders can take advantage of the little price differences across markets because crypto assets fluctuate constantly and are a 24-hour market. It is important to understand how exchanges determine cryptocurrency prices so you can fully grasp the complexity of crypto arbitrage trading. There are price discrepancies across platforms because not all exchanges determine cryptocurrency prices the same.
This means that the price of Bitcoin on a cryptocurrency exchange platform like Binance might be $25,678, while the Bitcoin price on another crypto exchange like Coinbase might be $25,650, showing a price difference of $28. An arbitrage trader looking to take advantage of the price difference will decide to buy Bitcoin from Coinbase and sell it on Binance, making some profit. We must understand that fees will be incurred during this transaction, reducing profit.
Crypto Arbitrage Trading Strategies
There are different types of crypto arbitrage strategies, all of which take advantage of the price differences in various parts of the market. We will be examining a few in this article. Some of the major types of crypto arbitrage strategies are:
- Simple arbitrage
- Triangular arbitrage
- Convergence arbitrage
- P2P Crypto Arbitrage
Simple Crypto Arbitrage
Simple arbitrage is a method of making money by exploiting price differences between markets for the same item or asset. It’s the same as buying an item at a low price and then selling it for a high price at another location to earn a profit.
This simple example will help you to understand.
So imagine that you are looking in two stores, both of which sell the same item. Store A sells the same toy at $10, while Store B offers it for $15. You’ve made $5 if you purchase the toy at Store A and immediately sell it back at Store B. You made a profit because you could take advantage of the difference in price between the two shops.
Prices for the same product can differ due to various factors, such as location, demand and supply, timing, or market inefficiency. Arbitrage is a way to profit quickly from price variations with little risk. They buy and sell the same item almost at the same time.
The markets tend to be efficient. This means arbitrage chances are usually short-lived, as traders will quickly eliminate price differences. Simple Arbitrage is important in maintaining prices across markets.
Triangular Crypto Arbitrage
The process of triangular arbitrage may be a little more complicated than simple arbitrage, but I will try to make it as simple as possible.
Triangular arbitrage is a way to exploit the inconsistencies between cryptocurrency exchange rates on the market. As its name suggests, triangular arbitrage is based on exchanging three currencies on three cryptocurrency exchanges due to their price differences. Here’s how to break this down:
Imagine having three coins: Coin A, B, and Coin C. You then discovered you can exchange these coins on different websites, and each website gives you a different amount of coins for another.
Now, let’s say you also discovered something interesting. If you start with Coin A and trade it on one website to get Coin B, then trade Coin B on another website to get Coin C, and finally trade Coin C back to Coin A on a third website, you end up with more Coin A than you started with! This means you have discovered a triangular crypto arbitrage opportunity.
It’s like when you trade your coins on only one exchange but then discover that if you trade a particular coin on the exchange for different coins on two other crypto exchanges, you get more of the original coins back at the end. This trick is called triangular arbitrage.
But there are some important things to remember:
- Quick Moves: You have to be fast because the amount of coins you get for trading can change quickly.
- Not Always Easy: Finding these special opportunities is like finding hidden treasures. They don’t always happen, and you need to search for them.
- Watch Out for Costs: Sometimes, the websites might take a few of your coins as a fee when you trade. So, you must ensure the extra coins you get are more than the coins you lose as fees.
- Not for Everyone: Triangular arbitrage can be tricky and might not work well for everyone, especially if you’re not careful or don’t understand how it all works.
Remember, just like crypto opportunities, there are risks. The websites might not always work perfectly, and you might not always make extra coins. So, if you ever want to try this, ask someone who knows a lot about it to help you.
Convergence arbitrage is a crypto-market trick some use when they discover that prices for similar items behave strangely.
So, let’s imagine that you have two coins with similar prices. Let’s use the United States Dollar (USD) and the United States Dollar Tether (USDT) as case study. For some reason, the crypto arbitrage trader discovered the USD, which is usually the same price as the USDT, becomes more expensive than the USDT. This can immediately become an arbitrage opportunity for the arbitrage trader.
Now, let’s understand how it works.
- How to Spot the Difference These smart arbitrage traders pay attention and immediately notice that the USD is more expensive than USDT, even though their prices are almost the same.
- Betting: They then do something exciting. They bet that the strange situation will not last long.
- Buy and Sell: To make it work, the arbitrage trader buys USDT, which has become less expensive, while selling USD, which is more costly. They hope to profit when prices return to normal.
- Waiting For Normalcy: If after some time, the clever people are right, and prices return to similar levels, then they can reverse what they have done. Then they sell the USDT they purchased earlier and buy the USD. They will make more money because they bought low and sold high.
This form of arbitrage trading can also be done outside the crypto space in your general market. You might notice that two chocolate bars are priced the same, but in one shop, one is suddenly selling for much more. You buy the less expensive bar, then wait for the prices to be the same before selling the higher-priced one.
Remember, it’s not easy. You’re solving a complex puzzle. Prices might not always return to normal, which means you could lose money. People who engage in convergence arbitrage must understand how the prices are calculated and act fast.
P2P Crypto Arbitrage
Last on our list of crypto arbitrage techniques is the P2P crypto arbitrage trading technique. It is very popular in countries like Nigeria, where cryptocurrency transactions and dealings have not been completely legalized, making it impossible to carry out cryptocurrency transactions using banks.
Firstly, P2P trading means Peer-to-Peer trading, and this method of arbitrage trading is done between individuals or single entities, making it possible to transact crypto without the direct involvement of the bank. In this process, one party is known as the merchant, while the other is known as the client. The P2P merchants help carry out Crypto to Fiat transactions and vice versa.
For example, we have Mr A as a client who wants to sell some crypto coins he had acquired long ago but cannot sell the coin into Fiat/cash as it is impossible to use his local bank for such transactions. Mr. A then contacts Mr. B, who happens to be a P2P merchant, and tells him he wants to sell his coin.
Mr. B will then give Mr. A the rate he will charge to convert the coin to Fiat/cash. Once Mr. A agrees with it, Mr. A will then send the coin to the wallet of Mr B while Mr. B will send the cash in the local currency of Mr. A to him. The same process occurs if Mr. A decides to buy some coins.
In this process, the merchant makes his money through price differences and easily gets his profit through conversion rates. I will explain how that is also done.
P2P crypto arbitrage can be achieved by posting buy and sell ads in P2P marketplaces such as Binance, Remitano, Kucoin, etc. In this instance, you set up buying and selling advertisements for volatile trading pairs such as USDT/Naira on the platforms I mentioned.
Still using Nigeria as a case study, if you want to buy a particular coin, since you can’t deposit your naira directly from your bank to the crypto exchange platform, what you need to do is to get to the P2P marketplace and then look for any merchant with a USDT sell ad and buy USDT from them directly using your naira. After getting the USDT, you can use it to get any coin you want and vice versa.
As a P2P crypto trading merchant, let’s say that the USDT/NGN market price is N900. You will create a buy ad under the market price — N899 while simultaneously creating sell ads above the market price of N903.
What this means is the merchant is buying USDT from the client at N899, and selling the same USDT to those who need it at a higher price, therefore making N4 profit on each USDT transaction.
Let me further break it down. Looking at the price above, anyone who wants to sell their USDT will have to sell to the merchant at N899, which is N1 lower than the market price, and then the merchant can sell the USDT to other clients who want to buy it for a profit at a higher price in this case N903. This strategy requires you to constantly check your buy/sell orders and adjust them according to changes in the market price.
It is also important to consider any additional charges, such as transaction fees, imposed by exchanges on ads placed on their platform.
Nonetheless, if done correctly, you can make a consistent profit with a much lower level of risk. The P2P crypto arbitrage strategy is a good source of additional income, especially for those from countries where the P2P market is very large and functional.
Like any crypto trading strategy, crypto arbitrage also involves risk. Although minimal, you must evaluate all the risks of using this strategy. Crypto arbitrage trading does not shield you against the risks of unanticipated and adverse market conditions; it only helps minimize the risk compared to other cryptocurrency activities. Exchanges may also experience server and network problems because they interact with blockchain and the internet.
Arbitrage trading might seem like a quick way to earn money. However, you should be aware that most exchanges charge fees for withdrawing funds, transferring cryptos, or trading them. Crypto arbitrage relies on minute price differences, so it is important to consider how much you might pay. Exchangers can charge you up to 4% to withdraw cash. Avoid paying excessive exchange fees if you wish to maximize profits.
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