What is cryptocurrency arbitrage?
Cryptocurrency arbitrage is the simultaneous purchase and sale of cryptocurrencies to make a profit due to the difference between the rates of cryptocurrencies on different exchanges. In such deals, often everything is decided in fractions of a second, or even milliseconds, so earnings depend on the speed of reaction and simple luck.The simplest algorithm for performing such operations is as follows: for example, quotes on two different cryptocurrency exchanges differ markedly. Accordingly, by buying an asset on the first exchange at a lower price and selling on the second at a more profitable one, the trader will receive his profit.
The concept of arbitrage came to the cryptocurrency market only a few years ago, although this strategy was popular in the stock market and has been used for a long time. In general, experts assess arbitrage trading as a strategy in which there is practically no risk of losing financial investments. In fact, the trader's actions are to speculate on profitability.
In arbitrage, market risk actually goes to zero, unlike technical risk, which is high.
Short-term disruptions in the operation of cryptocurrency exchanges, unstable Internet, all kinds of errors, restrictions on deposit and withdrawal of funds, and many other factors can lead to at least unfinished trading or even loss of funds.
Since, at present, the human factor has, in fact, been completely excluded from arbitration, all the work is done by robots. This is called high-frequency trading (HFT).
Bots are programs that work according to a special algorithm. The meaning of this idea is to search for the difference in the rates of the same trading pairs simultaneously on several platforms and conduct a transaction in an automatic mode. But the final profit still depends on fees.
How does the difference in exchange rates occur with Cryptocurrency Arbitrage?
In simple words, the essence of a cryptocurrency arbitrage strategy is to buy an asset on one exchange cheaper and then sell it on another exchange more expensive.It is the difference between trades that is the trader’s earnings in the over-the-counter cryptocurrency arbitrage.
But on what reasons and factors does the difference depend? There are several reasons:
Liquidity of exchanges. The value of the cryptocurrency on exchanges is determined by supply and demand. As an example of the value of Bitcoin, the difference in exchange rates can be several tens and sometimes hundreds of dollars.
Transaction delays. Not every cryptocurrency exchange can fully meet the demand for one or another coin; for this reason, transaction delays occur. As a result, the prices of various coins may rise, which creates favorable conditions for the effective work of arbitrageurs. However, this primarily concerns not the most popular resources;
The entrance of large players to a trading position or exit from it. It also happens that holders of significant amounts of cryptocurrency can suddenly sell a large amount of a particular coin at a lower price. Such an event immediately upsets the trade balance and creates uncertainty and chaos in the market.
Cryptocurrency arbitrage schemes and types
In total, there are two types of arbitration - spatial and temporal. The first involves instant trades, and the second deals at different times. Otherwise, the strategies of both types are approximately the same.There are several cryptocurrency arbitrage schemes. Of the most popular, there are three main ones:
Playing on the difference in exchange rates between exchanges
Suppose Bitcoin is trading at $ 10,000 on the Binance exchange and $ 10,500 at Exmo. According to this strategy, a trader buys 1 BTC on the first platform, transfers to the second and sells. As a result, a profit of $ 500 is made from the difference between buying and selling.
But not so simple. Although at first glance the scheme looks almost ideal, one should not forget about the fees that are taken for almost every action. The costs will be for the creation of orders on the first and second exchanges, for the transfer of cryptocurrency, and subsequent withdrawal.
As a result, instead of the likely $ 500 profit, the trader will receive much less. These costs cannot be ignored in the over-the-counter spread, which means that if the difference between the cost of coins is less than 3%, then there is no sense in such arbitration.
The main drawback of this scheme is the liquidity problem. Since the difference in the exchange rates of top coins is small, it makes no sense to use them for the arbitration of cryptocurrencies. In most cases, the difference in quotes is observed for altcoins:
It is from here that the liquidity problem arises, which is rather low for “second-tier” coins. It will not work quickly in large volumes to buy or sell such tokens.
At the same time, it should be understood that cryptocurrency off-exchange arbitrage is a completely legal and well-known strategy. Usually, bots are used here, which means that when there is a sufficient difference in rates for arbitrage, volumes are bought up instantly. Accordingly, all profits depend on performance.
Exchange deposits
In this scheme, the arbitration process is faster since there is no need to transfer funds from one platform to another. This is because this scheme is based on the storage of cryptocurrencies at two platforms at once, between which transactions will be conducted.Suppose a trader has 1 BTC and 100 EOS on exchanges A and B. When the exchange rate difference appears in the EOS / BTC pair, he buys EOS on the first exchange for BTC and sells all EOS on the second. Next, the balances of both platforms are manually leveled, transferring the purchased coins from platform A to B. At the same moment, the trader makes a transfer from the second exchange to the first missing part in BTC. As a result, the spread between these transfers will make a profit.
In this scheme, the trader does not spend time on transferring funds from one platform to another, but the problem of fees is not solved.
However, there are several disadvantages. Firstly, in this scheme, there is no possibility of choosing exchanges since the funds are stored at a maximum of three platforms. Not every trader has the opportunity to work according to this scheme, using a larger number of exchanges.
Secondly, the fee of transferring between exchanges is doubled because to equalize deposits, you have to transfer funds again.
Note that in this scheme, the second minus can be leveled. For example, if you work exclusively with one pair of cryptocurrencies. Suppose - BTC/USD or BTC/Stablecoin, since not all exchanges provide the opportunity to trade in fiat.
In this case, if on one exchange you see a significant difference in the exchange rate than on the other exchange, suppose, in a smaller direction, then you buy bitcoin, and you sell it on another exchange. To balance the scales, it is necessary to wait for the moment for the reverse arbitration of cryptocurrencies. Thus, an equal balance of funds will be maintained at both platforms, and the fee will have to be paid only for creating orders, but not for transferring cryptocurrency between the platforms.
Triangular arbitrage
Sometimes, such situations happen when inside one exchange, there is an opportunity to play on the difference in rates.However, this does not apply to one pair of cryptocurrencies but to quotes of several tokens at once. It is from here that the name triangle came. Ideally, the transaction is conducted according to such principle - buying BTC for dollars, buying EOS for Bitcoin, and selling EOS for dollars.
Of course, usually, the market is partly balanced, and the difference between the rates is not more than overhead, that is, the fee and spread. But on exchanges, similar situations still occur, allowing the arbitration of cryptocurrencies.
And here you need to understand that to independently calculate all the possible options for this kind of trade is almost impossible. Therefore, in this case, traders resort to the help of bots.
A high-quality bot for arbitration should be able to simultaneously calculate all the available options for exchange between several pairs, compare them, and select the most profitable transaction chains.
Here are some examples of good bots:
CryptoHopper
Gunbot. shop
Wunderbit Trading
3commas
Cryptotrader
HaasOnline.
The main drawback of triangular arbitrage is the existing risks. If you react to changes slowly, then the quotes can change, and then there will be no profit.
3commas
Cryptotrader
HaasOnline.
The main drawback of triangular arbitrage is the existing risks. If you react to changes slowly, then the quotes can change, and then there will be no profit.
Cryptocurrency arbitrage exchanges
Earlier, it was said that the arbitrage between exchanges is a completely legitimate earnings scheme, and the platforms themselves have nothing against this strategy. At the same time, arbitrageurs help exchanges rather than vice versa since they provide a large number of transactions and, therefore, increase liquidity.
Bots themselves do not have direct access to the user's balance, performing operations using the API. Accordingly, to work with the bot, you need to select the resource that supports this tool.
From all this, it follows that it is up to the trader to decide which exchange is suitable for work. At the same time, it is not necessary to track quotes on a hundred platforms; it is enough to choose 4-5 of the most convenient and reliable, since the difference in rates appears on all, without exception.
When choosing an exchange, one must take into account that there may be different rules for users from some countries. It is worth paying attention to the size of fees and the ability to minimize them. For example, in Binance, it is possible to pay a fee in the Binance Coin (BNB) OTC token. Thus, the size of the commission will be reduced by 25%.
Pros and Cons of Arbitrage Between Exchanges
Pros:Good income. In this case, the basis of earnings is the speed of the installed software. The higher the speed of execution of transactions, the greater the income received. However, much depends on the performance of the exchanges themselves.
Low risks. Even if the deal fails for any reason, the losses incurred will be minimal.
Cons:
High entry threshold. Naturally, you can start with a small amount, for example, $ 100, but then the maximum profit for a successful transaction will be a few dollars. That is why in the case of over-the-counter arbitrage, the final earnings depend on the invested funds; the larger the deposit, the greater the profit.
The need for continuous monitoring. Of course, a bot is a good and useful tool, but this does not mean that it does not need to be controlled. And, despite the use of the bot, no one cancels personal monitoring of exchange rates on exchanges. It is impossible to leave the situation without control.
Fees. It is they who eat the largest portion of the revenue from arbitration. Therefore, you need to select a site based on the fees of the site. And it is precisely because of the fees that the scheme of exchange deposit discussed above is most preferable.
Rules for successful earnings on arbitrage with cryptocurrencies
In short, the main rule of inter-exchange arbitration comes down to a simple formula: latecomers pay money to those who come first. This strategy requires a lot of effort, painstaking work, and the collection of detailed information. At the same time, one cannot fully and completely rely on a robot because the algorithm of actions for it was written by a person.However, due to market growth and the number of arbitrageurs, it is almost impossible to act manually.
A trader is simply not physically able to simultaneously monitor the market situation and at the same time quickly and correctly respond to changes.
To quickly respond to price fluctuations occurring at certain intervals, resources with special software tools will be required. Here are some of them:
From all of the above, the five rules of inter-exchange arbitrage trading can be noted, based on which a trader can minimize risks and make a profit:
- Automation of the arbitration process using a robot/bot.
- Work on reliable platforms. Of course, a big difference in rates often appears on not very popular exchanges. But this does not mean that it is worth blindly running there and buying. Technical work, restrictions on deposit and withdrawal, low transaction speed, and, ultimately, low liquidity. All of this can significantly affect earnings.
- Trade in large volumes. As mentioned earlier, the larger the deposit, the higher the earnings.
- The use of cryptocurrencies with high network transactions. That is why altcoins are most preferred with over-the-counter arbitrage. After all, Bitcoin is not famous for speed, and a transaction can go from exchange to exchange from 10 minutes to an hour.
- Enter and exit at the right time. Using a cryptocurrency arbitrage strategy is better in a calm market than in a state of chaos.
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