A SMALL GUIDE ON ARBITRAGE IN CRYPTOCURRENCY MARKETS
Disclaimer: this is an educational piece to help readers better understand the various arbitrage opportunities available in the cryptocurrency market.
There are more than 2,000 cryptocurrencies trading on 200 exchanges. Arbitrage opportunities arise among these various markets, and traders are already capitalizing on these opportunities. The cryptocurrency market is still young and growing. Because it is in its early stage, there are bound to be inefficiencies. For keen traders, this presents a golden opportunity for Arbitrage.
Definition — Arbitrage is the practice of taking advantage of a price difference between two or more markets. For example, an arbitrage opportunity is present when there is the opportunity to instantaneously buy something for a low price and sell it for a higher price.
Here is a step by step guide on how to make money on arbitrage with cryptocurrencies:
Step 1: Find opportunities (between exchanges or within exchange)
Step 2: Make a decision whether to buy or not to buy:
Also, evaluate the following before your decision:
1) Estimate amount of fees: transaction, transfer, network, wallet fees
2) Be aware of risks: transaction and transfer time, market volatility
3) Estimate the amount of taxes
This is the most simple method of conducting arbitrage.
To find an arbitrage opportunity is an essential step. There are two major kinds of crypto arbitrage:
- Arbitrage between exchanges
- Arbitrage within an exchange
Arbitrage between exchanges
Arbitrage between exchanges is the most obvious type of arbitrage because it is very similar to the fiat currency arbitrage (e.g. forex arbitrage) or to the sports arbitrage. The idea is simple: benefit from the differences in prices for the same coin but on different exchanges.
Let us split the process into steps:
- Register on multiple exchanges of your choice
- Deposit fiat on one exchange and buy a Bitcoin or any other cryptocurrency
- Transfer cryptocurrency to the other exchange
- Sell your crypto asset for fiat
- Withdraw the profit
- The first catch is that almost always you have to pay a fixed fee for each step. The subject of fees is quite complex, you can read all about in the section below. But just to give you an idea, you might pay as little as 3% of your crypto asset or as much as 15%, depending on the exchanges.
It is possible to reduce the amount of fees and also waiting time. Here is how you could do it step by step:
- Register on the exchange 1 and 2
- Deposit fiat on exchange 1
- Deposit fiat on exchange 2
- For a part of deposit buy a cryptocurrency on exchange 1, now you have fiat and crypto on this exchange
- For a part of deposit buy a cryptocurrency on exchange 2 , now you have fiat and crypto on this exchange
- When arbitrage opportunity presents, buy a cryptocurrency on the exchange 1 and sell the same amount of the cryptocurrency on the exchange 2 at the same time, or vice versa.
- Here there is no transfer of the cryptocurrencies between exchanges, which means neither waiting time, nor fee for this step. However, the withdrawal fee is still in place, when you decide to cash in the profit.
Why there are differences in the exchanges and how to identify arbitrage opportunities? Here are a few ideas:
Liquidity: difference in the trading volumes at different exchanges, meaning the difference in supply and demand, affects the prices. On the established exchanges prices fluctuate less than on the smaller or new ones.
Geography — while something can happen in the morning in Europe, that influences prices, most of the people in the US are still sleeping, hence the price difference may occur due to geography.
Listings — price difference when a crypto coin gets listed in one of the major exchanges.
Moving assets between exchanges means withdrawing funds from one exchange, making a transaction on the blockchain, and then depositing the funds in another exchange to complete the next transaction. Each of these steps incurs fees and is time-intensive. In the time it takes for a transaction to complete on the blockchain, a profitable opportunity can disappear. Executing a series of transactions within a single centralized exchange is much faster, and arbitrage opportunities can still be found within a single exchange.
Arbitrage within an exchange
Arbitrage within an exchange happens using cross-currency arbitrage. The step-by-step process is then as follows:
- Start with a deposit of some amount of fiat on an exchange
- Buy cryptocurrency 1
- Sell cryptocurrency 1 and buy cryptocurrency 2
- Repeat steps 2 and 3
- Sell cryptocurrency 2 for fiat
- Withdraw the profit
- You could substitute fiat with yet another cryptocurrency, or repeat step 2 many times with different cryptocurrencies. In the last case, it will be not a triangular arbitrage, but polygonal arbitrage.
By staying within an exchange and applying the same process over and over again to different cryptocurrencies, the major fee (withdrawal of cryptocurrency) is eliminated.
The catch in this case though is that the opportunity is less obvious than in the case of arbitrage between exchanges.
Here is an example of triangular arbitrage or cross-currency arbitrage. Let’s say that you have deposited some funds to an exchange and bought USDT, which you might consider a crypto equivalent of USD. You want to buy 1 Bitcoin (BTC). Of course, you could buy 1 BTC for 6527.06 USDT (on the 20th of August 2018, 04:26 CET).
Now we will understand what is Triangular or 2-legged Arbitrage
Buy Ethereum or ETH for USDT, 1 ETH = 302.15 USDT
Buy BTC for ETH, 1 ETH = 0.04643 BTC, or 1 BTC = 21.5378 ETH
Then your BTC would cost 21.5378*302.15 = 6507.64 USDT.
That means, to buy BTC via ETH you saved 19.41 USDT, which is about 0.3% of the Bitcoin price. If you sell immediately 1 BTC for 6527.06 USDT, you will make 0.3% profit of these 2 transactions.
The catch here is to make several transactions as the example above to cover deposit and withdrawal fees.
Note — Before conducting any arbitrage, it is extremely crucial to evaluate the fees involved in the activities. These fees include deposit and withdrawal fees, fixed transaction fees, maker and taker fees, and taxes. Hence, it is ideal to select exchanges and cryptos taking all these relevant factors into consideration.
Oct 28, 2019