Cryptocurrency arbitrage – introduction
Cryptocurrencies became one of the most versatile forms of investment. This results from two main factors: 1) many traditional investment strategies available to other assets are also applicable to cryptocurrencies, and 2) investing in cryptocurrencies allows for strategies that are not available to other kinds of investment.
As we have discussed in this post before, crypto investing is not only adequate to conservative strategies, which aim to obtain profit in the long-term, but it is also suitable to aggressive strategies, which aim to gain fast profit in the short-term. (See this text).
The important point is to pay attention to the fact that short-term strategies are usually riskier than long-term strategies. Therefore, they are mostly recommended for people with greater expertise and a good knowledge about this kind of investment.
However, there are also short-term strategies that are adequate for beginning investors (as long as they are well informed about what they are doing). Recall that in the finance world there are no absolute truths. There is only what you are comfortable enough in doing, based on your own studies and personal experience.
In this post, we shall talk about a simple and very efficient strategy for making profit in a short-term period: the cryptocurrency arbitrage.
You will learn what arbitrage is, what are the necessary steps to perform this investment strategy, its main risks and benefits, as well as many reliable sources from which you can keep your studies on crypto investing and try your primary steps.
What is arbitrage?
Arbitrage is a well-known concept in economics. It is a process in which a product is purchased with the sole goal of making an ulterior profit with the price difference between distinct markets.
Think of a person who buys a cheap object in the flea market with the only goal of reselling it to another shop with a bigger interest. This is arbitrage. The same happens when you buy a certain amount of a foreign currency in order to sell it for a higher price at another place.
In the case of cryptocurrencies, the process is exactly the same. In the same way that exist exchange companies for selling and buying foreign currencies, there are the exchanges for cryptocurrencies, i.e., companies that are responsible for mediating the process of buying and selling cryptocurrencies.
The crypto exchanges are very similar to regular brokers and other traditional financial institutions that mediate and regulate the process of buying and selling assets at the Stock Exchange. However, there is an essential difference between the products offered by regular brokers, and the products offered by the exchange, i.e., cryptocurrencies.
The value of a stock or a treasury bond is always the same across all distinct brokers. The factors that may influence someone for choosing one broker over another are details like fees, system usability, the number of products available, among others.
However, the value for buying a certain asset will never change between distinct brokers. If one share of Netflix stock is priced at $ 25,00 in a certain broker, it will cost the same in every other brother (as long as these stocks are being negotiated by brokers connected to the same Stock Exchange).
This is where you find the main difference between the assets sold by regular brokers and cryptocurrencies. Since cryptocurrencies are decentralized, they have no type of centralized control, therefore the value of cryptocurrencies among distinct exchanges may vary. (in this text you can learn more about decentralization and other advantages of cryptocurrencies)
All that means that if one unit of Dogecoin costs U$ 1,00 (fictitious price) in a certain exchange, the same Dogecoin unit may cost more, or less, in other exchanges. The value of Dogecoin (and any other cryptocurrency) can oscillate for distinct factors, thus allowing for different prices at the different exchanges in which the coin is being negotiated.
Thus, cryptocurrencies provide the perfect environment for arbitrage profit.
Since the value of assets will vary among distinct exchanges, one is allowed to take advantage of this fact and perform buying and selling operations of cryptocurrencies among distinct exchanges.
The reason for this is the fact that exchanges negotiate distinct volumes of cryptocurrencies, what creates a delay of price adjustment and generates good opportunities for arbitrage.
There are two main types of cryptocurrency arbitrage: 1) the arbitrage between distinct exchanges (also called triangular arbitrage), and 2) the arbitrage within the same exchange.
In the arbitrage between distinct exchanges, the goal is to purchase assets in a certain exchange and resell them at another exchange in order to gain profit with the price variation. It is even possible to perform the operation with exchanges from different countries.
In the arbitrage within the same exchange, the goal is to buy cryptocurrencies within the same exchange and resell them when there is a variation in price.
And what is the profile of people who perform the arbitrage strategy with cryptocoins?
Although it is apparently simple, cryptocurrency arbitrage is a financial operation performed by people with a good experience in the crypto market. These operators understand very well how certain phenomenon affects the value of cryptocurrencies across distinct exchanges. Thus, they are able to take advantage of this volatility.
These are people who understand very well the dynamic of this market and know how to anticipate and prepare for many contingencies.
Step by step
The step by step to perform triangular arbitrage is quite easy:
- Choose the cryptocurrency and purchase it at the exchange offering the minor price;
- Transfer the crypto to the exchange offering a higher price;
- Make the selling order.
For the arbitrage within the same exchange, the process is also easy:
- Choose the cryptocurrency and purchase it;
- Wait for the price difference;
- Make the selling order.
Recall that, in both cases, you will buy a cryptocoin of a cheaper value to resell it for a higher value. Therefore, it is necessary to pay attention to the prices and to be certain that the price difference will happen.
Not only that, it is also necessary attention with many essential factors at the time of performing the arbitrage, such as the selection of cryptocurrency, the choice of exchanges, among others.
Choosing the cryptocurrencies
There are no restrictions over which crypto is better suited for arbitrage. It is not only possible to make arbitrage with any cryptocurrency, but also with more than one at the same time. However, there are important recommendations at the moment of choosing the asset:
– Study the behavior of the crypto by evaluating elements such as the volume of transactions and the amount of exchanges that negotiate the coin.
– Study the volatility of the market at the moment in which you intend to make the arbitrage, i.e., do you understand all the processes occurring and why they are occurring?
– Be patient with choosing the cryptocurrency and executing the process. Many investors take decisions in a rush and end up losing part of their investments for mere lack of patience.
– Start from small steps, perform transactions of low volume and only after a good experience start with higher volumes.
Choosing the exchanges
As we have already discussed, the choice of exchanges is one of the most important factors for crypto arbitrage. There are a number of national and international websites that keep track of the values in each exchange in real time. You can start choosing an exchange from these places.
It is also necessary to be informed about other practical aspects, such as registration procedure, deposit confirmation, as well as other deadlines and limits for transactions. Each one of these factors may directly affect your arbitrage strategy.
Fees
Another important factor to be aware are the fees charged by the exchanges. The payment of fees may end up eliminating any possibility of profit from your arbitrage. This is a very serious factor of analysis, but unfortunately, many investors ignore it and create strategies with no possibility of profit.
Therefore, pay attention to all fees charged by each exchange involved in the transaction. Usually, they charge different fees for each transaction. Determine the value of each fee and estimate whether there will be any profit in the transaction.
Margin of profit
The margin of profit is determined by the value of purchase, the value of selling, and all fees and taxes involved in the operation.
For this reason, to calculate the margin of profit of your transaction is essential to be certain of executing an operation with good potential of profit. (If you do not know how to start investing in cryptocurrencies, you will find good help in this post)
Main advantages
The main advantages of crypto arbitrage result from the fact that it is a simple process with good possibility of short-term profit. By short-term, we mean a process that may take hours or days to end, depending on how the investor has structured the strategy.
But you should have in mind this is a strategy applicable only to cryptocurrencies. There are strategies that are similar, but with other assets, like stock trading. However, one should not confuse both. In arbitrage, the investor obtains profit with the price difference of assets negotiated at the Stock Exchange through the crypto exchanges. In trading, the investor profits with the price difference of assets exposed in the same negotiation platform on a given day.
Other advantages of crypto arbitrage are the following:
- Good variety of opportunities. There are hundreds of exchanges spread across the world, which provides a high price variation of cryptocurrencies.
- Less competition. The crypto market is still beginning, which means there are less competition on this market than in the usual markets.
- Easiness in transactions.
- Fast negotiation and profit.
Risks of crypto arbitrage
The risks of cryptocurrency arbitrage are consequence of some main features of cryptocurrencies, such as volatility and the very mode of organization of the market. The following are the main factors that affect crypto arbitrage:
- Fees charged to every negotiation.
- Withdraw limits. Many exchanges limit the number of withdrawals, what also limits the possibility of direct profit.
- Cryptocurrency volatility. This is a very important point. Cryptocurrencies are volatile, and exactly for this reason you must be very cautious with doing crypto arbitrage. One mere error of timing in the process of buying and selling and you may end up losing money.
How to acquire more information
Always remember to be well informed before starting any kind of cryptocurrency arbitrage. To make profit with strategies of this kind depends not only on the strategy itself, but also on your degree of knowledge and experience.
In the investment world there are no miraculous strategies or assets, there are only what you understand well enough to obtain profit. There are many books and websites from which you can learn more about bitcoin, cryptocurrencies, and investment strategies:
- The ECC Website is good source of information for anyone still in doubt about whether or not starting investing in crypto
- Other good sources of information about cryptocurrency investment are Crushcrypto and Binance
- There are also good books about the subject, such as
* Bitcoin for the befuddled, by Conrad Barski and Chris Wilmer. This is a very good and easy-to-follow introduction to the subject. You will learn about the main topics related to cryptocurrencies with a clear and concise language.
* The only bitcoin investing book you’ll ever need: an absolute beginner’s guide to the cryptocurrency which is changing the world and your finances in 2021, by Freeman Publications. The book is a thorough presentation of the subject, explaining how cryptocurrencies represent a revolution to the financial market.
* Bitcoin for beginners: the simple guide to investing in bitcoin and understanding blockchain cryptocurrency, by Artemis Caro. This is a three-volume book cotopics. It is definitely a good source of study.
Cryptocurrency arbitrage – conclusion
In this post, we have seen important information about how to execute correctly one short-term strategy for cryptocurrencies, namely cryptocurrency arbitrage. The highlights are the following:
- Cryptocurrency arbitrage consists in buying cryptocurrencies by a certain value and selling them at a higher price;
- There are two kinds of crypto arbitrage: 1) triangular arbitrage, in which the investor buys an asset at one exchange to sell it at another, and 2) arbitrage within the same exchange, in which the investor buys an asset at one exchange and waits for a higher price to resell it;
- Crypto arbitrage takes advantage of the fact that cryptocurrency values are not controlled by financial and political institutions;
- It is necessary to take very cautious steps before making crypto arbitrage. These steps involve choosing the correct exchange, the adequate cryptocurrency, studying the volatility of the market, as well as many other factors;
- Crypto arbitrage is a strategy for short-term profit, which demands good experience with the crypto market and has to be carefully planned;
- For beginners, the ideal is to execute arbitrage transactions with small values and small profit. After some experience, one may try transactions of higher volume and value in order to obtain higher profits;
- It is necessary to pay attention to factors that might affect your arbitrage strategy, such as the fees charged by the exchanges, the volatility of the chosen coin, the taxes in your country, as well as the amount of time required to complete the process;
- Get all information you can before starting any kind of investment. There are many books and websites available to sharpen your knowledge.
If you already have some knowledge about the crypto market, the arbitrage of crypto may be a good starting point for learning about more aggressive investment strategies. Start by studying and understanding the behavior of a single asset and move to more complex strategies only after you feel more comfortable.
If you’re interested in learning more about crypto market, keep following our blog with awesome content for every beginner investor!
