Crypto Arbitrage is a method traders use to quickly take advantage of the price differences between different exchanges where the price can be lower on one and higher on the other exchange. Traders are able to quickly buy low and sell it higher thus effectively arbitraging the price difference for a quick profit.
It’s not as simple as it sounds. There are many methods and risks involved in executing a successful arbitrage trade. In this article, we’ll dive into all the aspects of cryptocurrency arbitrage, what are the risks you need to look out for and how you’re able to take advantage of arbitrage opportunities when they arise.
What is cryptocurrency arbitrage?
Arbitrage has been around for a long time in traditional markets. It’s a simple concept of being able to buy something lower than market price and then taking advantage of the price difference to sell higher. So how does this apply to cryptocurrency?
In the crypto market, there are numerous exchanges – and because it’s all over the world and it’s hard for the price to be exactly in sync with the ‘market price’. Different markets could have different rules which affect the price of the cryptocurrency. Here are a few of the most popular arbitrage trading methods traders like to use.
How does cryptocurrency arbitrage work?
The standard method where traders spot an arbitrage opportunity on different exchanges. Lower price on one and higher price on the other. They can buy it one exchange A, then send it over to exchange B and sell it. Immediately making a profit.
Imagine exchange A sells Bitcoin for $9700, and exchange B buys bitcoin for $10,000. In this scenario, there’s a clear difference of $300 of arbitrage opportunities to be made. That’s a good profit if someone were to buy many bitcoins on A. Their profit would be $300 times the amount of Bitcoin they bought. If the trader invested ($9700 * 2 = 19,400) and sold for $20,000 that’s $600 profit.
This is how people are able to make large amounts of profits relatively ‘safely’. There’s a lot of other factors involved so we’ll cover those later.
Due to different rules, regulating, economic factors, and price difference of currencies, there is a good chance there are price discrepancies with different trading pairs. EG, BTC/USD and BTC/BRL (Brazillian dollar). Exchanges in different countries may also be exclusive to that particular country so foreigners are not able to trade on those exchanges. And that’s why it may be higher priced due to those investors not being able to access market rates themselves.
This method involves calculating the minute price difference after factoring in fees from all exchanges. Usually, traders utilize bots and complex trading algorithms to calculate the differences as it may only appear for a slim window of time to take advantage of.
Triangular Arbitrage – Investors use this method to take advantage of price differences of multiple cryptocurrency pairs. For example, Investors start off with BTC -> ETH -> BNB -> BTC. This method works by ‘stacking’ the price differences if all the currencies have a slight difference. To illustrate, imagine
BTC = $10,000
ETH = $400
BNB = $30
If the price is the same, 1 BTC = 25 ETH = 333.333 BNB
But here’s the kicker. Imagine if there was a price difference between BTC/ETH, ETH/BNB pair.
Instead of 1 BTC = 25 ETH, you get 25.1 ETH.
And instead of 25.1 ETH = 334.667…
You trade 25.1 ETH ($10,040) for BNB to get 335.667 BNB ($10,070) – as there is a difference in the ETH/BNB price for you to take advantage of.
Then you trade BNB back to BTC for 1.007 BTC ($10,070) thus making $70 profit from starting with $10,000.
With the triangular arbitrage method, this is how traders would be able to scalp the little difference to build into a sizable profit.
Flash Loan Arbitrage
This is a new method which has popped up recently due to the advances in Decentralized Finance (DeFi). It involves the use of flash loans to quickly trade in and out of different cryptocurrencies. We won’t go into too much detail on flash loans and exactly how decentralized finance works – but think of it as using the Triangular arbitrage method and stepping it up 500x.
Flash loans are much different than personal loans from a bank. Both types of loans charge interest so it’s crucial to compare rates. However, with Flash loans and DeFi, traders are able to borrow money faster, leverage different decentralized exchanges and quickly swap in and out of currencies within one transaction. Traders often trade between a few different cryptocurrencies to find a profit. There was a trader who was able to make 89% profits using this exact method – it’s highly risky but it’s incredible how he was able to pull it off. We’ll go over it later in this article to demonstrate how he was able to do it.
Is Cryptocurrency arbitrage profitable?
Cryptocurrency Arbitrage is 100% still profitable but it is a high-risk trading method where if you’re not experienced, we would not recommend it. There are many articles and videos where people make it look simple to do and easy to profit off of, but that’s painting the wrong picture for newer investors. More often than not, those people are just promoting their easy win ‘AI arbitrage bots’ which can make you bank without you lifting a finger. (If they really made so much profit, they wouldn’t be selling it to you).
Let’s break down the risks involved and factors where many people overlook when doing cryptocurrency arbitrage.
There are several places where fees occur.
- Whenever you buy and sell crypto on an exchange, there is a taker/maker fee. Which means for every transaction, the exchange will take 0.1% (depending on the exchange). So if you swap 1 BTC at $10k for $10k USDT, you won’t end up with $10k USDT. You’ll end up with $9,990 USDT ($10 goes to exchange). This fee can be higher or lower depending on various factors of the exchange. Some exchanges, like Binance, allow you to lower the rate with their native currency BNB. Other less known exchanges may have higher fees.
- Generally speaking, lesser-known exchanges have higher fees than usual so you would need to watch out for those and research all the trading fees involved before arbitrage.
- Withdrawal fees
- Most exchanges have fees so when you send cryptocurrency out of the exchange you have to pay then a small amount. This can range from a few cents to under a dollar – depending on the exchange.
Fluctuations in Price
- You have to consider this factor when looking at arbitrage opportunities. Imagine when you BTC/ETH is cheaper on exchange A compared to exchange B. In an ideal world, this is an easy profit. But what if, from the time it takes you to send your funds from A to B, the price levels out again? This would kill your profit margin and you would lose out on the withdrawal fees.
Time to Send
- Yes, sending cryptocurrencies is usually fast, but a lot of the times, it’s up to the exchanges to approve your deposits. Some exchanges may take longer than others to confirm. This is another risk investors need to consider – If it takes hours to get into your wallet, would the opportunity still exist?
- For sizeable arbitrage opportunities to exist, there is generally a reason why there’s a difference in price on one exchange versus another. A common reason why is wallet maintenance on the exchange. What this means is users with currency A on the exchange may be undergoing maintenance to that wallet and so users cannot move funds with that currency.
- So that could be the reason why BTC/currency A is more expensive on that particular exchange. Why this is a factor to consider is, if you were able to pull off this arbitrage, you now are risking the unknown time for wallet maintenance to complete and having your funds stuck on the exchange. You could theoretically lose your profits if BTC fluctuates past your selling point.
Exchange KYC/ Trust
- For arbitrage opportunities to exist, it typically happens on smaller, relatively unknown exchanges where prices are not exactly in sync with the major ones. So if you were to send funds to the smaller exchange, you would need to verify/trust the exchange and potentially go through their KYC system where you upload and verify your identity before being able to withdraw your funds.
Is Cryptocurrency arbitrage legal?
Cryptocurrency arbitrage is completely legal. It’s just a fancy term for buying low and selling high on a different exchange.
Bitcoin Arbitrage Example
Up to now, we’ve been negating these risk factors and we’ve been talking about arbitraging in an ideal world. Now let’s do a simple example and factor in the risks in a real-world arbitrage opportunity.
To set the stage for this scenario, let’s construct the properties of the exchange and the prices of the cryptocurrency we’ll be using.
- Bitcoin – $10,000
- Trading fees – 0.1%
- Withdrawal fees – 0.0004 BTC / $5 USD
- Bitcoin – $10,500
- Trading fees – 0.2%
- Withdrawal fees – $7
At first glance, it seems like it’s a sweet $500 profit we can make if we buy on Binance and sell on RandomExchange. Let’s see what we end up with.
We buy 1 BTC for $10,000 on Binance. Now we’re left with 0.999 BTC. And then we decide to send all our BTC to RandomExchange, so we now have 0.9986 BTC in our RandomExchange wallet.
Oh no! Because it takes around 1 hour for the deposit to clear into our RandomExchange account, the price of BTC on RandomExchange has dropped to $10,300 because people are doing what we’re doing and are selling.
When we’re finally able to sell our BTC, the price is already $10,250. So after the trading fees, we’re at 0.9966028 BTC * 10,250 – because we’re turning BTC back to USDT. We now have $10,215.17 USDT. That’s a $215 profit!
Oh wait! That’s not all. The reason why BTC’s price was a lot higher on RandomExchange compared to Binance was because people couldn’t withdraw their USDT. (There’s usually a reason why there’s a price difference on exchanges)
So now our USDT is stuck on RandomExchange with no timeframe of when we can withdraw. If we’re lucky, we keep the profits if BTC goes down in price. But if BTC goes higher than $10,250 (our selling point), we would lose all our profits.
Let’s say we get lucky and the wallet maintenance completes in 3 days. Bitcoin manages to trade sideways and is still $10,000. We transfer our USDT to Binance and take a $7 withdrawal fee. We’re now left with $10,208.17.
Finally, let’s buy back our BTC on Binance. We buy back 1.020817 BTC. Don’t forget the trading fee so we’re left with 1.019796183 or $10,198 USD. We managed to make a $198 profit on a $500 difference in BTC price – not bad!
This is the reality of arbitrage trading with many factors to consider. If you do want to try this yourself, a huge disclaimer we would give you is that, if you do need to send BTC to relatively unknown exchanges, make sure to take a look at their order book and see how well the volume of trade are doing.
The volume is essentially the amount of buy and sell activity going on. If Bob bought an apple for $1 and then sold it to Alice for $2, the volume is $3. It adds both buy and sell to measure the flow of money.
In smaller exchanges, the volume is typically smaller (which means no many people buying or selling), so the price tends to be higher. If you want to sell your cryptocurrency, there may not be people on that exchange wanting to buy.
Flash Loan Real Life Case Study
On Aug 10, 2020 this trader made a huge profit of $40k on a $45k initial investment because of this arbitrage opportunity.
Because of the technicalities of how DeFi works, we won’t go into too much detail but just show you how he was able to profit on a high-level overview.
The arbitrage opportunity was with stablecoins (coins that are always meant to be $1). The coins in this case study was USDC and USDT.
USDC was $1 and USDT was 0.91c on Uniswap. The reason USDT was 0.91c and not $1 on Uniswap was because of low liquidity – don’t worry about that for now.
So the trader saw this opportunity… he had $45k in funds but wanted more money to make a bigger profit. So he borrowed $405,000 off the decentralized exchange platform “dydx” – making his total pool of money $450,000 in USDC.
He then made the trade on Uniswap to buy $492,000 worth of USDT with his $450,000 USDC.
Then he traded $492,000 USDT for $492,000 USDC on another platform “Curve”. On there, USDT was $1 so that’s how he was able to get the same amount back in USDC.
Then he paid back his $405,000 loan to “dydx” and he now has $87,000 left. The total transaction fees and interest cost around $2000 so he netted a $45k profit.
But you may be thinking… ‘where did flash loans come into this?’
On ‘dydx’ they took a flash loan out for this trade. To put it simply, a flash loan is a loan where you’re able to do many transactions in a single block. Don’t worry about it too much, just know that the trader was able to borrow money, sell USDC into USDT, pay back the money within one transaction.
Thereby mitigating a lot of risk factors such as crypto transfer times, fluctuations in price, and also exchange trust – as these exchanges are completely decentralized- meaning they don’t need KYC as no one operates them. It runs by itself.
Pros Of Crypto Arbitrage
When the right opportunity comes, you’re able to make insane amounts of money in a short time with relatively low but calculated risk if calculated properly. Done right and you’ll be laughing at the easy profits.
But in general, crypto arbitrage is a super high-risk move with many factors you need to consider and calculate.
Cons Of Crypto Arbitrage
- Withdrawal and trading fees
- KYC verification on smaller exchanges
- Trusting random exchanges
- Wallet and Node maintenance
- Price fluctuation in the coin you’re trying to arbitrage
- Withdrawal limits on exchanges
- Slow transaction and clearing time
Important Things To Know Before You Try It
The other big thing you need to consider is the withdrawal limits and Know Your Customer (KYC) exchanges do. Are you comfortable in handing over your licensed information to smaller exchanges?
Typically, smaller exchanges have a withdrawal system where you’re allowed to withdraw a small amount of crypto per day if you’re unverified. Some might not even let you withdraw without verification – and some could take days to complete verification as well.
Coin Companion’s Thought’s on Arbitrage
We may sound like we’re totally against cryptocurrency arbitrage but that’s not the case. We just want to highlight the reality of what arbitraging is and the risks involved so you don’t fall for any ‘instant profit’ trading arbitrage bots and algorithms scammers are trying to sell you.
That being said, when you see the right opportunity and everything aligns correctly in terms of the maths, and you’ve given yourself enough margin of error – go for it! You take the risk and you reap the rewards. There are also several ways to reduce your risk but we might go into that in another article.