Arbitrage opportunities exist because markets are inefficient. Here are some strategies that traders use.
Crypto arbitrage trading is the practice of buying and selling the same token in different exchanges to benefit from price discrepancies between the exchanges.
The arbitrage opportunities only exist because markets are not perfectly efficient.
Since crypto exchanges are not directly connected, price disparities present arbitraging opportunities.
Arbitrageurs can leverage trading bots to gain profits and returns from crypto arbitrage strategies.
The inefficient nature of financial markets is driven by crucial dynamics like transaction costs, psychology, varying trading tools, strategies and the differences in the degree of information access among investors and traders. Arbitrage trading is born out the price discrepancies or market inefficiencies.
Arbitrage trading is a concept familiar in traditional financial markets, where traders purchase and sell the same asset in two different markets. The traders leverage the trivial price differences between the markets for profits. While the price discrepancy is trivial for individual shares, bulk buying may yield higher profits to a trader. However, due to traditional financial markets’ maturity, the profit margins in arbitrage trading are less.
The newness of cryptocurrencies offers new possibilities for this tool. Like leveraged and futures trading, arbitrage trading is slowly gaining attention to the crypto domain to open new opportunities for crypto traders to make profits and earn returns.
What is Crypto Arbitrage Trading?
With hundreds of crypto trading exchanges, the price of one token varies between the exchanges mainly due to varying liquidity flow, trading volumes, siloed crypto exchange activities, demand and supply, and processing time differences during depositing and withdrawal. Hence, crypto traders attempt to leverage the discrepancies by buying a crypto asset from one platform and selling it higher on another exchange.
Crypto arbitrage trading is the simultaneous buying and selling of the same token in different exchanges to benefit from price discrepancies between the exchanges. The idea behind arbitrage trading stems from the risky nature of hodling coins hoping that their price will appreciate.
Example: If Bitcoin currently trades at $49, 050 and $49,890 in Binance and Coinbase, respectively, a trader buys Bitcoin from Binance at $49,050 and sells it in Coinbase at $49,890. The trader earns a gross profit of $840 with minimal effort.
The rapid adoption rate of cryptocurrencies has directly influenced a surge in crypto trading volume. Therefore, traders can leverage the arbitrage opportunities presented by price differences of the same asset in different exchanges since the markets are not directly connected. Factors like fiat hyperinflation, political unrest, and fiat currency devaluation also promote premium trading for some cryptocurrencies. However, the prices of assets in financial markets will always vary to a certain degree, even without such factors.
Crypto Arbitrage Trading Strategies
Arbitrage trading offers the following opportunities and strategies to crypto traders.
1) Spatial/Pure Arbitrage
Spatial arbitrage is the most straightforward strategy to make profits from small price disparities. It is the practice of trading the same crypto-asset across two exchanges. Here, a trader purchases crypto from platform one at a lower price and sells it at a higher rate on the second platform. However, the trader should ensure the profit margins are worth the risk. In addition, the trader should consider the processing time, transaction fees, and any technical problems that may hinder the process. Time is of essence.
2) Convergence Arbitrage
This strategy involves a trader purchasing an undervalued asset and selling the overvalued crypto asset (buying long and selling short). The trader predicts the price movement of the first asset relative to the second asset. It is called convergence arbitrage because the trader buys the overpriced asset and sells the undervalued one when their values converge. Arbitrageurs can sell short in case of a market crash when the decline on the short is higher.
3) Triangular Arbitrage
Transaction fees are not involved in this strategy as it takes place on the same platform. A trader compares the price of trading pairs and takes advantage of the differences. For instance, a trader converts ETH to XRP, XRP to ADA, and ADA to ETH, completing a triangular loop. The strategy is a success when one asset is undervalued in the platform. The trader ends up with more ETH than before.
4) Statistical Arbitrage
Statistical arbitrage strategy employs qualitative data models, modern technological algorithms and bots to benefit from price disparities between two digital assets. The bots calculate enormous amounts of data using advanced technology and help traders execute instant trades. For example, the bot discerns between the excellent and low performers and determines to go short or long on trades. On the other hand, having a good algorithm can aid in forecasting market movements and trading against various assets.
The crypto industry is gaining momentum and slowly garnering mainstream adoption. The volatility of the crypto market and the increasing crypto exchange platforms open up profitable arbitrage trading opportunities. While arbitrage trading is a promising strategy, crypto traders should consider the trading fees and transaction speed.