Cryptocurrency arbitrage: how traders use price differences
Why are there price differences at different exchanges and what are the risks of such trading?
Cryptocurrency price differences on different exchanges allow traders to earn extra income. This method of trading is called arbitrage, and its essence is to buy tokens with the aim of reselling them at a higher price.
Arbitrage appeared on stock and currency markets a long time ago. However, at traditional exchanges, it is more difficult to trade according to this scheme, because the difference in quotes is very small. Cryptocurrency traders get more opportunities for this type of earnings due to significant differences in the prices of exchanges for digital assets.
What are the differences?
Exchange rate differences arise because of the different liquidity of trading on exchanges, On large platforms, there are many users and trading is active, so the quotes are always market. Small exchanges have low liquidity, so the rates on them may lag behind the market.
The expert named high commissions as another factor affecting the arbitrage. Fomin explained that the more the transaction costs, the less arbitrators are willing to undertake transactions, and the more likely is the formation of rate differences between large and small exchanges.
The difference in quotes may be due to the fact that trades to BTC, for example, go to different coins/currencies, said CEO of Wellcrypto. He gave the example that in one place it may be trading to USDT, and in another to the usual fiat USD.
Also, the expert believes that the difference in quotes and price may appear due to the fact that the deposit/withdrawal of the coin on the exchange is closed. He specified that because of this within the exchange there are their own, special conditions.
And if the deposit/withdrawal on the exchange is closed for a long time, the difference in prices can be quite significant. For example, this was the case recently with the LUNA coin.
The price of the asset is formed by the balance of supply and demand. He pointed out that for cryptocurrencies there is no central organization that publishes the official exchange rate, as it happens in the world of finance for currencies with a floating rate.
It's logical that different crypto exchanges will have different levels of supply and demand: just like with the prices of products in two neighboring stores.
The opportunity to make money on this difference greatly affects the supply and demand in a particular service, the expert said. He noted that this balances prices in the market, so "arbitrageurs" are, in a sense, extremely useful for the entire industry.
What schemes traders use
The most popular type of arbitrage is automated inter-exchange, with the help of bots. A robot independently analyzes hundreds of trading pairs on dozens of centralized and decentralized exchanges, transfers funds between exchanges and places buy and sell orders.
Human involvement in such transactions is minimal, just the initial setup and keeping it updated. Arbitrage is currently carried out in 99% of cases by automated trading systems.
According to him, such type of arbitrage as a triangle is widespread now. It works within a single exchange, the expert said. The chosen coin is traded in at least three pairs: the algorithm can buy ETH for USDT, then sell ETH for BTC, and at the end sell BTC in USDT. Thus, at the end the trader has a balance in USDT again.
In such a bundle, it's enough to get a small % of profit for arbitrage to be successful. He explained that even 0.01% plus, taking into account the commission already means that the bundle was successful. In his opinion, dozens or hundreds of such circles can end up yielding good profits in a day. This kind of arbitrage is especially profitable on exchanges with low liquidity, where there are market deviations, the expert believes.
Arbitrage between the spot market and the futures market is also popular, Podolyan adds. He said that futures involve both open-ended contracts and contracts with a limited duration (quarterly, monthly and so on).
As a rule, such arbitrage is good on strong market movements. When news impulses arise. There are splits between all the contracts that are traded
Trading risks
The biggest problem for arbitrage is freezing or delaying the withdrawal of funds. He explained that the discrepancy in exchange rates is usually a momentary event, which provokes a large number of people and robots to make money on this, so reaction time is very important. The longer it takes to move funds from one exchange to another, the more likely it is that you will miss the deadline and end up losing money because of commissions or changes in the price of an asset.
Bitfinex review also pointed out that there are risks of hacking of smart contracts, if decentralized exchanges are used. The expert noted that there is a dilemma: should the number of exchanges in question be increased at the expense of low-liquidity young projects, which often cause such discrepancies with centralized exchanges?
The expert warned that one should not exclude possible sanctions from the centralized services for suspicious activity, or in current realities for political reasons.
The expert called the potential backdoor in the trading robot another risk, which is not the most obvious. In order for the machines to work correctly, they need to provide API keys, which in fact give them full access to your money. And the developer, having the ability to manage remotely, can take advantage of this for his own selfish purposes, the analyst warned.
The underlying risk is the loss incurred because the price of the token fell during the transfer from exchange to exchange. This could be due to limitations in the exchange, transaction hang-ups in the blockchain and other factors that affect the speed of the transaction.
The expert advises to carefully check the selected tokens and platforms, as well as carefully enter the addresses for the transfer and the selected network, so as not to lose your funds due to haste.
Why cryptocurrency price arbitrage is not suitable for beginners, what are its features and what you should pay special attention to
Traders use price differences on cryptocurrency exchanges for their own benefit. This way of earning is called arbitrage, and its meaning is to buy an asset cheaper on one exchange and sell it at a higher price on another. Theoretically the concept looks simple, but in practice there are a lot of nuances which can ultimately deprive a newcomer of a deposit.
Not for Beginners
Cryptocurrency arbitrage is more suitable for "sophisticated" traders who may be new to digital money, but already have experience in trading other assets. According to him, no one deals with arbitrage manually nowadays, they use trading bots - programs for automatic conclusion of transactions under predetermined conditions.
The most famous and profitable funds are most often engaged in arbitrage, and this reduces all activity to a technology race.
Arbitrage requires experience in writing a connector (software to connect to a platform where assets are traded) to an exchange and trading strategies, as well as the ability to write yourself good software and use good servers.
The arbitration is not suitable enough for those, who are making their first steps in the market. The difference in rates of liquid tools at exchanges is "insignificant", therefore large sums of money are required for considerable earnings on arbitration. Besides it is difficult for private players to compete with large companies - institutional investors who use robotized schemes for tracking profitable patterns.
Not for Beginners
Cryptocurrency arbitrage is more suitable for "sophisticated" traders who may be new to digital money, but already have experience in trading other assets. According to him, no one deals with arbitrage manually nowadays, they use trading bots - programs for automatic conclusion of transactions under predetermined conditions.
The most famous and profitable funds are most often engaged in arbitrage, and this reduces all activity to a technology race.
Arbitrage requires experience in writing a connector (software to connect to a platform where assets are traded) to an exchange and trading strategies, as well as the ability to write yourself good software and use good servers.
The arbitration is not suitable enough for those, who are making their first steps in the market. The difference in rates of liquid tools at exchanges is "insignificant", therefore large sums of money are required for considerable earnings on arbitration. Besides it is difficult for private players to compete with large companies - institutional investors who use robotized schemes for tracking profitable patterns.
Types of arbitrage
The most accessible type of arbitrage is considered to be statistical, which can also be called paired trading. The point of statistical arbitrage is to find instruments with high correlation between each other. This type of arbitrage can be performed even manually, using the existing functionality of trading terminals. One more type of arbitrage is intermarket arbitrage.
Intermarket arbitrage is when you see the difference between the prices of one instrument on different markets and open a long position on one and a short position on the other simultaneously. As soon as that difference becomes zero - you close both positions.
In practice such arbitrage operations require a very fast communication channel and special software, he added.
There is also calendar arbitrage - it is more accessible and represents also the opening of two differently directed positions in contracts with different due dates. For example, buying April bitcoin futures versus selling May bitcoin futures. Thus, it is not a separate instrument that is traded, but the difference between them, or the spread. Until the expiration of the April contract, it is possible to "catch" small fluctuations in such a spread. However, such work would also require at least good software, because it is impossible to do this manually, the expert warned.