Trading crypto or any other volatile market is hinged on the concept of taking arbitrage. Arbitrage is simply exploiting gaps or inefficiencies in the market for profit. Arbitrage also involves simultaneously trading in different markets. You aim when prices are low and buy to sell when prices go up.
Arbitrage is a day trading strategy that has its pros and cons. A trader that wants to make gains through arbitrage must understand how the market works, the timing, season, and instruments he or she wants to trade.
In this article, I will explain how to make low-risk gains by taking arbitrage on crypto.
Key Takeaways
• Crypto arbitrage is a technique used by crypto investors to make instant profits from crypto exchanges.
• There are two types of exchanges, which are centralized and decentralized exchanges responsible for crypto price variations.
• Crypto Arbitrage comes in different forms, with the most basic being cross-exchange arbitrage.
• Anyone can engage in crypto arbitrage trading as this technique is not reserved for crypto experts or experienced crypto traders.
SEE ALSO: How To Arbitrage Between Crypto Exchanges For Gains
How Crypto Arbitrage Works
The arbitrage technique is used to profit from price differences across multiple exchanges or even the same exchange.
What this means is that an investor buys the crypto on an exchange and then sells it simultaneously on another exchange where the price is slightly higher.
There is also another form of arbitrage, referred to as “intra arbitrage,” where investors exploit market price variations to make a profit.
In this form of arbitrage, all you need to do is to buy a crypto asset, transfer it to another crypto asset, and then transfer it back to the first asset to make a small profit. This form of arbitrage is way more complex than the first.
What is important here, however, is that you can do both types of arbitrage with little to no risk, and you don’t even have to be an experienced investor or trader to make profits from this.
Other types of crypto arbitrage include spatial arbitrage, decentralized arbitrage, and statistical arbitrage.
Making low-risk gains
Crypto arbitrage trading is not the same as regular crypto trading, where you need to predict crypto prices or utilize techniques for hours before you begin to see results in the form of profits. This is the major reason why it is considered a low-risk gain.
So if you want to make these low-risk gains, all you need to do is to exploit the loopholes in the crypto market to the fullest in terms of varying prices, and you can expect to get profits from doing so.
The profit you gain in this case is fixed because it is not determined by market sentiments or predictions. As such, making them is significantly less risky compared to traditional trading.
While traditional trading could take you hours before something can be achieved, with arbitrage trading, you could be done in seconds or minutes.
Now, the next thing most investors usually ask is why prices are different on various exchanges when there is supposed to be some sort of uniformity.
To answer this question, you need to understand that crypto exchanges are not all the same, as some are centralized exchanges while others are decentralized exchanges.
Let me explain a bit or two of what I mean by centralized and decentralized exchanges:
Centralized Exchanges
Other than the fact that centralized exchanges are exchanges that are controlled or regulated by a central or financial authority, prices of cryptocurrencies here are determined by the most recent price at which they were bought and sold.
So, for instance, if 1 ether was recently sold for $100,000 and that was the latest sale on the exchange, that would automatically become the price it would be listed at on the exchange until another transaction takes place.
Hence, what this means is that irrespective of the general price of that crypto, the price of that particular crypto remains what it was at its last sale on a centralized exchange.
Decentralized Exchanges
Unlike centralized exchanges, decentralized exchanges make use of automated market makers (AMM) to determine crypto prices.
They do this to make sure that the prices on the decentralized exchange correspond with the prices found on other decentralized exchanges.
Also, instead of using market pairs or matching to undertake a trade found in centralized exchanges, decentralized exchanges make use of liquidity pools, which basically do the same thing: ensure that trading can take place at any given time and you don’t need to look for a trader to be paired with for trading.
In each liquidity pool, crypto assets are usually funded voluntarily by other crypto traders who are willing to let go of their assets to provide liquidity so that other traders can trade against them in exchange for which they receive a share of the pool’s transaction fees as a reward.
With this incentive, there are always liquidity pools for traders who are willing to trade their assets on an exchange.
Now that you understand why prices are different on different exchanges and how arbitrage traders make their profits, you must keep in mind that, despite crypto arbitrage trading being a low-risk technique, there are some challenges that you might face as a crypto arbitrage trader.
These challenges are as follows:
Time
One thing about arbitrage trading that makes it a bit challenging to profit from is its time sensitivity. Knowing the best time to reap the highest profits is always important as a crypto arbitrage trader.
You see, crypto price margins tend to be reduced as more and more arbitrage traders try to profit from these price discrepancies due to the competitive nature of the blockchain.
This simply means that if Mr. A buys 1 ether at $15 on Binance and then sells it for $15.30 on eToro and Mr. B tries to profit the same way using the same crypto, he will see a lower price discrepancy, which means fewer profits for him.
This process continues until there are no more price discrepancies and prices become equal on both exchanges.
Fees
As a crypto arbitrage trader, you will need to pay certain fees for transactions and trading on these exchanges, and these will lower the expected profits you would earn after their deductions.
Security
Sometimes, scams and hacks can be detrimental to the funds you plan on using to carry out your arbitrage transactions. As such, you need to be careful with the exchanges you make use of, making sure they are trustworthy and well-known.
Frequently Asked Questions (FAQs)
How do you do arbitrage trading in crypto?
Arbitrage trading in crypto is quite easy. You simply purchase crypto on an exchange and sell it for a higher price on another exchange.
This form of trading is usually seen as a less risky form of trading compared to the traditional crypto trading done by investors.
Does arbitrage exist in the real world?
Yes, it does, as has been explained in this article. Successful arbitrage relies on the fact that different crypto prices exist on different exchanges.
Final Thoughts
Crypto arbitrage is a fantastic way of making profits as a crypto trader. You do not even need to be an expert to start utilizing this opportunity to the fullest.
Just make sure to take note of some of the challenges listed above before you begin, and you should be good to go.
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