What is it and how does crypto arbitrage work?

Crypto arbitrage is one of the most interesting practices as well as one of the most profitable to pursue in the digital currency financial markets.

It is not an easy and affordable method to make gains in the crypto sector and it requires good basic knowledge, a fair amount of capital and advanced skills to be profitable in the long run.

Let’s see together how crypto arbitrage works

Crypto arbitrage: how it works and what the main concepts are

In order to get started with crypto arbitrage, it is essential to first understand what the main concepts are.

Arbitrage involves taking advantage of price discrepancies of a cryptocurrency on two different markets.

Indeed, a cryptocurrency may be listed on different markets (centralized or decentralized) where prices are not always aligned. Normally they are more or less the same, but it can sometimes occur that significant variations ranging from 1% up to even 30%+ can be observed.

The smaller a cryptocurrency is in terms of capitalization and popularity, the easier it is for significant discrepancies to occur.

For example suppose (without considering fee costs) that the price of BTC on Binance is $30,000, while on Coinbase it is $30,500.

What can the traders do to profit? They can “simply”:

  • Buy 1 BTC on Binance for $30,000;
  • Transfer 1 BTC from Binance to Coinbase;
  • Sell 1 BTC on Coinbase for $30,500.

In this case the “net” profit is $500.

However, be careful, because in reality it is not that simple: there are so many variables at play and it is difficult to take advantage of these opportunities that the markets generate in a timely manner.

The volatility of the markets, the fee costs and the operational time involved in making these kinds of trades should definitely not be underestimated.

The 3 basic rules for doing crypto arbitrage

Let’s take a look together at what the fundamental rules are for doing crypto arbitrage professionally and profitably.

First of all, pay attention to a central detail: it is absolutely not possible to know in advance what the precise profit will be from this practice.

This is explained by the fact that arbitrage opportunities are generated day by day, and one cannot expect to have a fixed return.

Instead, approximations can be made, but remember that those who promise you gains are lying to you.

In order to do arbitrage it’s essential to follow these 3 rules:

  • If you don’t have enough start-up capital, the taker/maker fees of exchanges to execute orders and the fees for transferring a cryptocurrency from one exchange to another could eat up your earnings entirely. Forget about starting doing arbitrage with only 100 euros.
  • Price discrepancies are often short-lived: at times you may have seen major price changes, even on highly capitalized cryptocurrencies. However, generally these opportunities vanish after a few minutes, due to the high participation of bots and automated arbitrage systems that definitely operate faster than manual work. In addition, many exchanges take a very long time to make crypto deposits, sometimes more than 20 minutes
  • It is always worth considering the liquidity factor within exchanges, especially for less capitalized crypto assets. There are often arbitrage opportunities but there is very little liquidity on exchanges. In these cases you risk incurring large losses

There would actually be a fourth rule to follow as well, and it represents a warning for the cryptocurrency market in general, and not just as it relates to arbitrage.

Do your research and make sure that the exchange you want to transact on is reputable. For instance, think about all the users who were conducting arbitrage transactions on FTX in November 2022

Beware of scams

The cryptocurrency world is rife with scams of all kinds, from phishing attempts and fake websites to malicious smart contracts and exchanges that use customer deposits to make withdrawals for others (ponzi scheme).

Speaking of fake websites, it is interesting to note that recently, at the official launch of the Arbitrum airdrop, there were more than hundreds of cases of fake websites, with identical interface to the official website, created ad hoc to steal the private keys of users trying to make the ARB token claim.

Certainly, the greatest number of scam platforms are found in the arbitrage niche. This is probably due to the fact that the promise of high daily returns, appeals to numerous untrained players, who punctually end up “giving” their money to these criminals.

Of course, there are also legit platforms where crypto arbitrage is done in a clear and transparent way, without promising fixed income and without deception of any kind.

Unfortunately though, these cases are very few.

As in every sphere of life, technological innovations bring with them positive and negative aspects.

The advent of cryptocurrencies and blockchain has fostered the spread of the ideals of decentralization, transparency, and freedom, but they have also, alas, triggered the proliferation of a long line of bad-faith actors, who try in every possible way to siphon off capital from the less knowledgeable.

For this reason, knowledge of basic Web3 concepts is essential if one is to endure in this vicious yet fascinating world.

Stay alert traders!

 


Source: https://en.cryptonomist.ch/2023/04/15/what-is-how-crypto-arbitrage-work/