What Is Crypto Arbitrage And How Does It Work?

Key Takeaways

• Crypto arbitrage takes advantage of price differences across different exchanges in pursuit of quick profits.
• Crypto arbitrage requires quick execution and a deep market understanding of price movements.
• There are various crypto arbitrage strategies with the most popular being the triangular and spatial arbitrage adopted by traders.
• Automation and the use of trading bots will increase the likelihood of traders making profitable crypto arbitrage trades. 

Crypto arbitrage refers to the act of simply buying a cryptocurrency at a spot price on one exchange and selling it at a higher price on another. The intention here is to capitalize on the price differences between platforms.

This strategy, known as arbitrage trading crypto, requires swift execution and a deep understanding of exchanges. Crypto arbitrage strategies can be exploited in both traditional markets and the cryptocurrency market. Here traders try to seek and take advantage of arbitrage opportunities and benefit from market mismatches in price.

How Does Crypto Arbitrage Work?

Crypto arbitrage capitalizes on price differences across multiple exchanges. These discrepancies happen because of factors to do with liquidity, trading volume, and regional regulatory differences. Below one can identify a series of steps on how to arbitrage crypto:

• Step 1: Identifying Price Differences: Monitor multiple exchanges to spot price differences for the same cryptocurrency. For instance, Bitcoin might be priced at $66,763 on Binance and $66,846 on Dex-Trade.
• Step 2: Executing Buy and Sell Orders Simultaneously: Once a price difference is identified, the trader buys the cryptocurrency at the lower price on Exchange A and sells it at the higher price on Exchange B simultaneously. This type of quick execution normally locks in the price difference before a market adjustment.
• Step 3: Transferring Funds Between Exchanges: Traders might need to transfer the purchased cryptocurrency from one exchange to another to complete the arbitrage process. This step involves moving funds quickly. 
• Step 4: Calculating Profit: To determine the net profit, traders must account for various costs, including trading fees, transfer fees, and potential slippage.

Types of Crypto Arbitrage Strategies

There are various kinds of strategies that may be adopted which are listed below:

Triangular Arbitrage

Here traders exploit price differences between three or more cryptocurrencies within a single exchange. For example, a trader might notice a price discrepancy between Bitcoin, Ethereum, and Litecoin. The trader can proceed to cycle trades between these currencies and the trader can lock in a profit without needing to move funds between different exchanges.

Time Arbitrage

Time arbitrage involves monitoring the same cryptocurrency on a single exchange to take advantage of price fluctuations over time on the same exchange. This strategy requires patience and an understanding of technical analysis.

Spatial Arbitrage

Prices can vary between exchanges located in different parts of the world due to local demand, regulatory rules, and trading volume. For instance, Bitcoin might be cheaper on a U.S.-based exchange compared to an Asian exchange.

Cross-Exchange Arbitrage

Traders buy cryptocurrency on one exchange where the price is lower and sell it on another exchange where the price is higher. It is the most common form of arbitrage trading adopted.

Inter-Exchange Arbitrage

This strategy exploits price differences between trading pairs on the same exchange. For example, if there is a price difference between the BTC/USD and ETH/USD pairs on the same exchange, a trader can simultaneously buy and sell these pairs to make a profit.

Statistical Arbitrage

Statistical arbitrage uses mathematical models to identify mispriced assets. Traders leverage algorithms and statistical tools to analyze historical price data and predict future price movements.

Step-By-Step Guide To Getting Started With Crypto Arbitrage

The below steps explain how crypto arbitrage takes place:

1. Research And Choose Reliable Exchanges: To begin arbitrage trading, the individual trader must research and select reliable exchanges with good liquidity and low fees..
2. Create Multiple Exchange Accounts: The trader should set up accounts across multiple cryptocurrency exchanges. This step will allow for cross-exchange arbitrage and spatial arbitrage.
3. Create Multiple Crypto Wallets: You may need different wallets for different types of cryptocurrencies, as not all exchanges support every coin. Ensure that your wallets are secure and can handle the specific cryptocurrencies you plan to trade.
4. Monitor Cryptocurrency Prices To Identify Opportunities: Trades should try to make use of software to monitor cryptocurrency moves or manually follow attentively to prices across various exchanges. Once a potential price discrepancy occurs, the traders act quickly.
5. Develop A Trading Plan And Risk Management Strategy: Start with small amounts to minimize risk and gradually increase the trade as a suitable strategy fits the trader. A trading plan and risk management strategy through experience will be developed over time.

Advantages of Crypto Arbitrage

There are various advantages of crypto arbitrage, as explained below:

Profit Potential

One of the main advantages of crypto arbitrage is the potential to make profits. By taking advantage of price differences between exchanges, traders buy low on one platform and sell high on another, capturing the spread as profit.

Market Efficiency

Arbitrage trading crypto contributes to market efficiency. By balancing prices across different exchanges, arbitrage helps to reduce price differences over time between exchanges. This activity ensures that prices of cryptocurrencies remain aligned across various platforms.

Lower Risk

If the trader is experienced and aware and follows the steps taking time to understand a healthy arbitrage strategy, traders can expose themselves to an art form that will allow for effective crypto arbitrage trading that allows for considered lower risk. 

Accessibility

Arbitrage opportunities for crypto are accessible to anyone with accounts on multiple exchanges. Traders may therefore participate and potentially profit from arbitrage, provided they understand the basic principles and follow a strategy that suits that individual.

Automation Potential

One significant advantage of arbitrage trading crypto is the potential for automation. Traders may use bots to monitor markets to execute trades faster than humans, increasing efficiency and the likelihood of making profitable trades.

Risks Involved in Crypto Arbitrage

Despite its advantages, crypto arbitrage carries inherent risks if adopted by an individual. 

Price Volatility

Rapid price changes may quickly remove opportunity to make instant potential profits or even result in losses. Market volatility, in this situation, which might be a difficult player to predict can erode forecasted price discrepancies before trades can be executed.

Exchange Risks

Arbitrage trading crypto also involves exchange-specific risks. Issues such as exchange hacks, downtime, or withdrawal problems will disrupt arbitrage trades. 

If an exchange goes offline or restricts withdrawals, this delay will trap funds preventing the ability to make use of arbitrage trading.

Transaction Fees and Slippage

Fees associated with trading occur when making a transfer and withdrawing funds which will dampen net profit made from arbitrage. 

Additionally, slippage occurs when the market price changes between order placement and execution, which diminishes returns.

Competition 

Arbitrage opportunities for crypto can be difficult to make in large assets like Bitcoin. Many traders use automated bots which continuously scan the market for arbitrage opportunities, these bots make it difficult for novice arbitrage traders to profit on price discrepancies.

Regulatory Risks

Changing regulations might impact profitability when considering which crypto arbitrage strategies to adopt. 

Regulatory shifts affect exchange operations, transaction fees, and the legal status of cryptocurrencies in different regions, introducing uncertainty and potential obstacles for arbitrage traders.

Crypto Arbitrage Case Study: Sam Bankman Fried

Sam Bankman-Fried, the founder of FTX, allegedly made his billions through crypto arbitrage strategies. Initially, he identified price discrepancies between Bitcoin prices on U.S. exchanges and Asian exchanges, a classic example of spatial arbitrage.

After purchasing Bitcoin on the cheaper U.S. exchanges he began to sell that BTC at a higher price on Japanese exchanges, Bankman-Fried and his team were able to profit from the price differences in the billions. 

This strategy adopted included triangular arbitrage, which was also used to exploit price differences between multiple cryptocurrencies within the same exchange, and statistical arbitrage, which used advanced algorithms to identify mispriced assets, allowing Bankman-Fried to build his fortune fast.

Bankman-Fried misappropriated FTX customer funds for personal use, made investments, and contributed millions to political campaigns across both parties. He also used these funds to repay billions in loans owed by Alameda Research, a cryptocurrency trading firm he founded.

Furthermore, Bankman-Fried deceived lenders to Alameda and equity investors in FTX by providing false and misleading financial information that hid his misuse of customer deposits. From 2019 to 2022, he orchestrated a scheme to defraud FTX customers by misusing billions of their dollars. As a result, he was sentenced for 25 years in prison in March 2024.

Conclusion

Crypto arbitrage takes advantage of price differences between exchanges and leverages this weak point to make profits. While it may offer a profitable trade it also comes with risks such as price volatility, exchange issues, and regulatory changes. 

Interested traders should conduct thorough research to experiment cautiously and to understand the difficulties associated with this form of trading.

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About the Author

Andrew Kamsky

Andrew Kamsky is a writer and chart analyst, holding a degree in Economics and an ACCA certification. Andrew’s professional background spans roles at a Big Four accountancy firm, a fintech bank, and a chart analyst position at a listed bank focusing on foreign currency hedging. Beyond his financial career, Andrew is passionate about music, glass neon lights and travel.

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