The advancements seen in cryptocurrencies have seen new methods by which users can make money online with crypto . There are several methods an individual can make money online. However, this article will be focusing on a technique that is not well-known to a vast number of individuals; this method is called cryptocurrency arbitration.
We would talk about what crypto arbitration is, the types of crypto arbitration, if arbitration is profitable, how to calculate profits when using arbitration, and how to go into cryptocurrency arbitration, factors to consider before partaking in cryptocurrency arbitration, pros and cons of arbitration, and if it is wise to go into crypto arbitration.
What is Arbitration?
This is a method of generating extra profits on investment by buying assets on a particular exchange. Then, these assets on another sale have a significant price difference to the first exchange you purchased from.
This might seem like a means of illegal earning, but it is not unlawful, although various discussions frown upon such methods.
Now that we know what arbitration is let us talk about what cryptocurrency arbitration means.
What is cryptocurrency arbitration, and how does it work?
Crypto arbitration is a method of earning additional income by buying a specific cryptocurrency (BTC) on one exchange and selling this BTC on another conversation with BTC stated at a higher price. Therefore, the profits realized are the difference between the prices of Bitcoin on the two exchanges. However, as easy as this method seems, it is a lot complicated, the main limiting factor being the fees imposed on making transfers to a different cryptocurrency exchange. These fees can significantly reduce your profits and probably lead to you losing money instead of making profits.
A question that is probably in your mind is, “why are prices different across exchanges?”. The price difference seen on different exchanges worldwide is due to the decentralized nature of most cryptocurrencies. Therefore, since there is no regulating body in charge of these coins, there is no standard price worldwide.
The prices seen on sites such as coinmarketcap, the go-to place for information on over 8,000 unique digital currencies, are just averages taken across several well-known digital currency exchanges.
For instance, the prices of BTC on Binance might be NGN 16,500,000 per coin, while the Bitcoin price on another exchange might be NGN 15,500,000 per coin; by this, there is a difference of about NGN 1,000,000. Therefore, a properly carried out arbitration trade can see profits realized from the difference between Bitcoin prices on these exchanges.
Now that we understand how arbitration applies to the world of cryptocurrency let us talk about arbitration types.
Types of cryptocurrency arbitration
There are four main types of cryptocurrency arbitration, and they include;
- Simple crypto arbitration.
- Triangular crypto arbitration.
- Statistical crypto arbitration.
- Automated crypto arbitration.
Simple crypto arbitration
As the name suggests, this is a kind of arbitration that simply involves purchasing a cryptocurrency asset on a particular exchange, transferring it to your wallet on another exchange, and selling this same asset. This is the method of arbitration we earlier portrayed. This arbitration method does not require many trades except those that are necessary to carry it out. Essential trades are mostly seen when the desired asset is not available on the exchange you wish to send the funds.
Therefore, an illustration of a simple crypto arbitration would be;
| The current price of BTC | The current price of BTC |
| On exchange A | On exchange B |
| NGN 15,500,000 | NGN 16,500,00 |
| Difference between exchange A and B NGN 1,000,000 | |
| |
| The user buys 1 BTC from exchange A and sends it to exchange B. | The user receives the sent BTC (1BTC) from exchange A |
| User sells the 1 BTC (now worth 16,500,500 by exchange B standards). |
| Users makes a profit of NGN 1,000,000, which is the difference between the exchanges. |
Take Note: As earlier mentioned, the fees of exchange A might cancel out the potential profit; this is done by reducing the amount of cryptocurrency that is sent to exchange B to an amount that will correspond to a price that is similar or even lower compared to that of exchange A. Therefore, it is essential to carry out extensive research into the digital currency you wish to use, considering the transfer fees and price difference.
Triangular crypto arbitration
This is another option for arbitration that can involve either the same cryptocurrency exchange ( amongst three different coins) or between different exchanges. In this method, the price differences between three other cryptocurrencies on the same business are used to profit.
To better understand how triangular arbitrage works, let us take an example.
We would be using Bitcoin as the first asset, Ethereum as the second, and Litecoin as the third asset. All these assets are known to have a considerable price gap between them.
Using the triangular arbitrage method, we would begin with an asset (Bitcoin), and by the end of this arbitrage, we would arrive back at Bitcoin.
- Using Bitcoin, trade it for Ethereum.
- Trade the newly acquired Ethereum for the next asset, Litecoin.
- Trade this Litecoin back to Bitcoin.
This method takes much more effort than others, as it requires calculated moves, taking note of the ask and bid prices of all the involved cryptocurrencies, which help you discover opportunities to make a profit.
Statistical crypto arbitrage
This method of crypto trading arbitrage is considered the most complicated in contrast to the other forms listed. This is because it requires the trader to access up-to-date market statistics and requires that the trader opens and manages multiple trades simultaneously. This has several risks because historical data does not always repeat itself and human errors are likely to occur.
Automated crypto arbitrage
This is a cryptocurrency arbitrage method that involves using an automated trading tool called trading bots to carry out arbitrage trades for its user. This is an easy method of arbitrage trading as you do not have to continually keep track of the price changes in an exchange or across several businesses.
There are also different subsets of automated crypto trading tools, and these are;
Several automated cryptocurrency trading tools are available, such as Hassonline, crypto hopper, Coinrule, 3commas, etc.
Now that we understand what cryptocurrency arbitrage is and the types, let us discuss what makes cryptocurrency arbitrage profitable.
Why is cryptocurrency arbitrage considered profitable?
Due to the crypto space setup, there are many discrepancies in the prices of various cryptocurrencies across several exchanges. Therefore, crypto arbitrage offers several benefits such as;
Crypto arbitrage provides an alternative to long-term investing and also short-term trading using technical analysis. This is because it requires minimal knowledge of price charts and trends and is considered a reliable way to make money online.
This method allows users to make quick profits on their initial capital with minimal risks involved.
The increasing creation of new exchanges provides an even broader market for arbitrage trading, creating several opportunities on many digital currencies.
This method is not commonly used. There is less competition, which translates to less attention drawn to this method.
The price differences across various exchanges can be as little as 3% and as high as 30% in some cases. This creates significant profit, most especially when using large sums to trade, as it makes it worth your time.
There are several other reasons an individual can go into cryptocurrency arbitration. However, these are the most common reasons. Now that we understand the possible cause or opportunities cryptocurrency arbitrage brings, we will now discuss how individuals can calculate or estimate potential profit and loss in crypto arbitrage.
How to estimate profit and loss in cryptocurrency arbitrage trading
Knowing how much it will cost you in trade is significant in accounting for expected fees and accurate estimation of potential profits. Some factors to take into consideration include;
The market volatility. A proper example of market volatility is seen in Bitcoin, as it can either rise or fall with thousands in seconds. Therefore, before a trade is executed, the prices might change.
Transaction fees: this is a very significant factor in arbitrage. Various exchanges impose different fees on different actions or transitions. Some examples of fees to take into consideration include;
Taker and makers: these are fees imposed when removing and creating liquidity on an exchange, respectively. These fees differ across different exchanges. Usually, the taker fees are higher than the maker fees, and this is because liquidity is being taken from the exchange. Some exchanges sometimes do not even charge maker fees.
Deposit fees: when initiating an arbitrage, a cryptocurrency needs to be bought. However, these fees differ across exchanges, and it is advisable to always compare several exchanges before choosing any.
Withdrawal fees: when withdrawing your funds to either another exchange’s wallet or to your personal wallet, there could be fees for that, and this mostly depends on the crypto asset you wish to withdraw.
With all these factors to consider, it is always essential for adequate research to be carried out before carrying out an arbitrage trade. Now that we understand how to calculate potential profits or losses in arbitrage let us talk about the risks attributed to arbitrage trading.
Risks of cryptocurrency arbitrage
Generally, cryptocurrency trading has many risks. However, crypto arbitrage has an increased number of risks. Some of which are because of;
The crypto market volatility creates a degree of uncertainty on the price action a currency might take.
The transaction fees also pose a risk. This is because if the difference in prices of the asset across various isn’t high enough, the transaction fees that would be imposed on the action might be significant enough to make you lose money instead of gaining money.
As earlier stated, arbitrage is more profitable when significant sums of funds are used. However, some exchanges require individuals to fill a KYC form before they are allowed to transact large funds.
Understanding the risks of any action in the crypto space is essential in minimizing losses. Now that we have seen possible risk factors that could affect successful crypto arbitrage trading, let us sum up the pros and cons of such a trading method.
Pros and cons of cryptocurrency arbitrage trading
Here are notable advantages and disadvantages of arbitration.
Pros
- This form of trading allows for quick profit-making without requiring much knowledge about technical analysis.
- Due to the decentralized nature of cryptocurrencies, there are no fixed prices for assets, leading to a lot of price discrepancies, which create arbitrage opportunities.
- Because crypto adoption is still in its early stages, it is fair to say that this method of earning money online would be available for a while.
- Crypto arbitrage trading is easy and less time-consuming.
Cons
- Any mistake made while transferring funds across different exchange wallets can lead to an irreversible loss of funds. Caution is highly advised.
- Various exchanges have their transaction fees. Therefore, this can lead to potential losses.
- Cryptocurrency arbitrage allows for trades in minute time frames. Therefore, a fast reaction is required by the trader. This, however, can not always be efficient.
- With more advancements being created, many more individuals will begin to use this method to make gains, leading to a reduction in the number of opportunities created.
Now that we understand the pros and cons of crypto arbitrage, should an individual begin cryptocurrency arbitrage?
Should you begin cryptocurrency arbitrage?
This can serve as a good source of making passive money with crypto. However, there is no direct answer to this question.
It is always advisable to carry out adequate research, develop a good strategy and beware of the risks involved before going into cryptocurrency arbitrage.
Conclusion
This article extensively examines cryptocurrency arbitration, how it works and if it can be a profitable source of passive income. There are several other methods by which an individual can make money in crypto, to learn these methods, read this article by Remitano.
