Arbitrage opportunities in the crypto space have become common. You may have noticed how cryptocurrencies trade at varying prices on different exchanges and markets. Even the popular liquid digital currencies like Bitcoin and Ethereum trade at different prices in various markets. Crypto investors are using these opportunities to make the most out of their digital assets by taking advantage of the varying prices across multiple exchanges. Arbitrage investing strategy is becoming popular because it has relatively lower risk. It does not need price predictions, and you do not have to be a crypto expert to excel at it. However, arbitrage may not be as straightforward as it seems. Here is what one needs to understand about arbitrage.
What is arbitrage?
Crypto arbitrage is the process of purchasing cryptocurrencies from one exchange and simultaneously selling it at a higher price on a different platform. Arbitrage is common in other financial markets for fiat currency and other physical assets. Cryptocurrency prices deviate significantly over short periods, but they trade throughout the day or week on crypto exchanges. Price deviations provide users with a legit opportunity to profit in the volatile market. Traders are primarily interested in taking advantage of the varying prices. Knowledge about price discrepancies across exchanges is substantial in arbitrage strategy.
Types of crypto arbitrage
- Triangular arbitrage – involves making a profit from trading with more than one pair of listed cryptocurrencies. Here users take advantage of price differences of three or more currencies and earn money by making several conversions. For instance, you can purchase BTC using USD and some profits, use BTC to buy ETH and convert back USD.
- Regular arbitrage – involves buying cryptocurrency from one exchange and selling it immediately on another exchange with higher prices for the same coin.
- Automated arbitrage – Due to its popularity, some platforms has specialised in providing crypto users with automated arbitrage. Users need to deposit funds and set up a plan to take advantage of price discrepancies. ArbiSmart is an example of a platform offering automated arbitrage.
Using the three arbitrage approaches will attract a good amount of profit. Trading high volumes of cryptocurrencies on the same exchange qualify you for fees discounts that positively impact your profits. However, triangular arbitrage is a more complicated strategy, and it can be challenging to discover price discrepancies on the same exchange. It is more manageable to use third-party arbitrage software to ensure accurate trading. Remember to check the cost of third-party services to maximise profits.
Why crypto arbitrage is a profitable strategy
Low-risk trading
Arbitrage strategy is considered low-risk because users do not depend on price predictions. Users solely rely on the volatility of the crypto market and take advantage of the constant price changes to make money. It is impossible to lose your assets in this strategy unless there was a mistake when checking the prices.
Quick profits
A regular approach is arguably the fastest way to profit using an arbitrage strategy. Unlike most investments, arbitrage only take seconds, minutes or a few hours to generate profit. Some investments not using arbitrage can take days or months and never generate anticipated returns.
Less competition
Arbitrage is not facing stiff competition from traditional businesses. Traditional businesses still appeal to most investors, leaving arbitrage and other crypto opportunities open. This will soon change as experts argue that crypto is becoming a popular investment tool. Crypto users can use these opportunities by buying vast amounts and selling at higher prices to earn money.
Variety of opportunities
The Crypto market has thousands of cryptocurrencies and hundreds of crypto exchanges. The variety of digital currencies and exchanges offer users a more comprehensive range of opportunities to look for price disparities and trade to earn profit.
The cryptocurrencies market is young yet volatile
The crypto market is young, and new exchanges and currencies are still being introduced. When exchanges enter the crypto space, there are no preset prices for them to follow. Instead, they analyse the market trends and work on prices independently without consulting with other exchanges. This contributes to the sudden drops and picks in prices, creating arbitrage opportunities for investors to benefit.
What to consider when using the arbitrage
- Tax policies in your area of jurisdiction- note that profits earned from cryptocurrency trading are taxable income is classified differently from one jurisdiction to another. It would help if you considered the taxes deducted while using an arbitrage strategy to determine potential profits.
- Maker and taker fee charges at the purchase point (on exchange 1)
- Withdrawing commissions at purchase exchange
- Depositing charges at the selling point (exchange 2)
- Cashing out charges
- Market volatility- some cryptocurrencies prices change too often than you expected, which could interfere with the earned returns.
How you can calculate the costs and earnings of arbitrage strategy
To calculate arbitrage costs and profits, you need to consider your area of jurisdiction, classification, and taxation. Here are some examples.
For instance, you get an arbitrage opportunity to trade fiat to crypto. A crypto exchange, let’s say Coinbase, is selling Ethereum at $10,000 while another exchange, Crypto.com, is selling Ethereum at $14,000. The two exchanges have a difference of $4,000 (note this example is just for illustration.) If you buy 2 ETH from Coinbase and sell at Crypto.com, you will earn $8,000. When depositing your funds to purchase cryptocurrencies, you may incur charges depending on the exchange used. The $8,000 earned is tax-deductible depending on your area of jurisdiction or classification. It may be deducted when cashing out if the exchange used is not free.
It will take about 20 minutes to deposit Ethereum in the Crypto.com wallet. Note that deposits may be free on some exchanges while other charges deposit fees. During the 20 minutes, Ethereum prices could rise or fall due to the highly volatile nature of cryptocurrencies, and it can impact your profit. While selling the ETH tokens at Crypto.com, you will be charged takers fees. You can choose to continue using arbitrage opportunities or withdraw the amount to incur extra cashing out charges. All the costs and expenses reduce the total expected profit. It is advisable to use the most profitable arbitrage opportunities to ensure you still enjoy earnings after deductions.
How to choose exchanges for crypto arbitrage
The cryptocurrency market is highly volatile and yet profitable. If you want to take advantage of price differences on the crypto exchanges, you need to evaluate the platforms to determine which will work best to your advantage and trade safely. The hundreds of exchanges available in the market have different policies and fees. For instance, some exchanges require a verified account and one to attain a specific deposit to start selling cryptocurrencies. Other exchanges use KYC or AML approaches to qualify people to trade on their exchanges. Security is also essential when selecting an exchange to avoid theft risks. This is what to consider when choosing.
The reputation of an exchange
Reputation is the first consideration to put in place when selecting an exchange. There are new exchanges in the market that have not earned investors’ trust. Remember, you use personal details while interacting with the exchange. To be safe, select a famous exchange with a good track record.
Fees
The more fees incurred on a particular exchange, the less the profit. Some of the fees include depositing fees and withdrawing fees. It is best to go for a low-fee exchange to maximise profit.
Processing time
Transaction’s speed is essential in a space where prices change within minutes. Exchanges facilitating fast transactions are better and cheaper than exchanges with poor transaction speed that are costly.
Depositing and withdrawing times are essential considerations. Some exchanges dictate that manual funds withdrawal can only happen once a day.
Geography
Some features on an exchange or even exchanges are restricted in a specific area. Before depositing your funds for arbitrage, you need to ensure you can complete all the necessary transactions from your location.
Market liquidity
It is recommendable to check if an exchange has enough liquidity to enable you to trade in volumes. Some exchanges only maintain limited liquidity on their platform, limiting the amount of profit.
Account verification
Account verification can take days or weeks. Some account limits you from using funds to trade or withdrawing them until the account is verified.
Wallet maintenance
You may find that an arbitrage opportunity is caused by maintenance routine in specific exchanges. It may be difficult to deposit trade or withdraw funds from an exchange during maintenance. Ensure that you can make transactions before selecting an exchange.
Here is a step-to-step crypto arbitrage process
Find arbitrage opportunities
You can find opportunities easily with the help of tools such as coingap, tokenspread.com, coinarbitrage.org, crypto arbitrage app and arbitrage.expert. These tools will help you identify price differences between major cryptocurrencies and exchanges. You can also use automated programs to discover arbitrage opportunities.
Make a decision
Once you identify the price differences, you need to decide which is worth it. To know the most profitable arbitrage opportunities, you must consider some aspects. Tax deductions are considerations where you weigh how much your profit will reduce. Deposit, wallet, transaction, transfer, network and withdrawing fees are additional costs that reduce your earnings, and you must estimate them before taking the arbitrage opportunity. Remember, the crypto market is highly volatile, and things like wallet maintenance could contribute to price differences.
If you decide to invest in arbitrage opportunities, you must keep funds in various exchanges. You can fund your wallets using fiat currency or cryptocurrencies. Being ready to take advantage of crypto price differences before spotting an opportunity will save you the precious time required to make verifications and deposits.
Popular blockchain like Ethereum and Bitcoin get congested during pick hours. Congestion contributes to a slow transaction rate and increases the gas fees required to complete transactions. But, the two cryptocurrencies are very profitable; you need to know when to take the opportunities.
Arbitrage automation program
Investors have embraced the use of automated programs that constantly evaluate various exchanges to determine price differences and calculate potential profits. Automated programs use bots to scan cryptocurrency prices on different platforms. Examples of companies offering automated services include ArbiSmart, Arbitao, Haasonline Software, Gimmer and Gekko. Traders benefit from faster and more reliable results while using computerised programs. However, such programs are not without their downsides, and you need to be careful not to place an amount you cannot afford to lose. Arbitrage opportunities happen within short spans and can be tasking to keep track of prices.
The bottom line
Arbitrage trading will continue to grow popular as cryptocurrencies gain wider adoption. Costs and fees, security, offered currency pairs, withdrawal options and pricing are essential to look at before taking any arbitrage opportunities on an exchange. The crypto market itself is very volatile, putting your funds at risk. Remember, it is your responsibility to be cautious and research digital assets to avoid massive losses.
