What is Cryptocurrency Arbitrage? Ultimate Guide to How Arbitrage Works

  • George Shnurenko
    📚 WikiCoin

    There are good opportunities in cryptocurrency arbitrage if you know what you are doing

What is Cryptocurrency Arbitrage? Ultimate Guide to How Arbitrage Works

As cryptocurrency becomes more mainstream, we are eager to apply conventional trading principles to the decentralized system of finance. Even though these new techniques might face stiff resistance at first, with time, we will realize the importance of being amenable to the new developments. As at now, one of the most important concepts in crypto-market is cryptocurrency arbitrage and how it works.

What is arbitrage?

First, let’s seek to understand what arbitrage is and the applications. Arbitrage is the term which explains the phenomenon when an investor buys an asset and then quickly sells the particular asset so as to benefit from a change in price. While this definition might not do justice to the topic, an example will suffice.

Assuming you purchase shares of your preferred company for $100 in New York Stock Exchange and then you sell this same asset on the London Stock Exchange platform for $110, you have had the chance to earn a $10 profit on this particular trade.

What is cryptocurrency arbitrage?

Now that you’ve learned the simple and important process which helps acute investors make a profit on the irregularity of the market, we can easily understand how to arbitrage cryptocurrency. It is important that you note, however, that cryptocurrency arbitrage opportunities are found on different digital exchanges. For instance, if Bitcoin is selling for $6,000 on one exchange and $6,250 on another, this is a perfect opportunity to arbitrage Bitcoin.

Finding cryptocurrency arbitrage opportunities

For now, the greatest challenge is finding opportunities to arbitrage cryptocurrencies and it seems as though a cryptocurrency arbitrage bot would be ideal for such a task. Combing through exchanges manually would be a very laborious mission and it is very unlikely that you will get the best deal or the highest profit margin without the help of a cryptocurrency arbitrage software.

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Steps to take when executing a cryptocurrency arbitrage

The process of executing a cryptocurrency arbitrage is, no doubt, a very difficult one. However, you’re lucky to have this guide readily available. You will learn the different steps you need to adhere to which will make the process seamless.

1. Find a suitable opportunity to arbitrage cryptocurrency

While we have mentioned how you can benefit from arbitrage bots for cryptocurrency, there’s little for you to do here if you follow due process. If you remember, the cryptocurrency market is unregulated, diffused, and, honestly, an easy target for arbitrage bots. For example, one time, CEX, a South Korean exchange, had Bitcoins at $10,026 while it was selling for $9,748 on Kraken - a US exchange platform.

Similar events occurred in the past when the difference between Japanese and US exchanges was as high as $400. An arbitrage bot for cryptocurrency will definitely make your job easier here, simple.

When you can identify the exchanges with the highest disparities, calculate the spread (highest bid – lowest ask) and then take action.

2. Execute the trade

After you find the perfect exchange for your arbitrage deal, a delay can be dangerous. There’s every possibility that others also saw the same deal and will swoop in before you. Provided that you have enough funding to cater for the purchase, place a bid and ask for bid accordingly. For example, if on Kraken, Bitcoin is going for $30 (just an example, don’t panic yet), and on Coinbase, it is available for $50, you can place a bid for one BTC on Kraken and request for a bid on Coinbase. The rest, as they say, is history.

3. Rebalance your account

Now that you’ve made a hypothetical profit of $20 (or so you think), you will need to send one BTC back to the account where you withdrew from (Coinbase in this instance) to balance it out. Keep in mind that cryptocurrency arbitrage can only be done once in a day. Although, nothing stops your cryptocurrency arbitrage software from gathering information as at when due.

Trading fees for cryptocurrency arbitrage

Why are arbitrage cryptocurrency bots important? If the price discrepancy is not sufficient, you might eventually lose more than you earn due to trading fees. Consider a trading fee of one percent. At first, it might appear small and insignificant. However, consider the real-life scenario where Bitcoin actually costs $9,240. Buying one BTC will incur $92 in trading fees. On the sale, you will spend another $92, coming up to $184. When you consider the time and effort spent on scouting for cryptocurrency arbitrage opportunities, you might begin to wonder if it really is worth it

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Why aren’t we all partaking in cryptocurrency arbitrage?

Even if we made cryptocurrency arbitrage software readily available to everyone, some people will still pass up on the offer. Here are some reasons for that.

1. Cryptocurrency arbitrage needs real-time devotion

When we compare the arbitrage of cryptocurrency to Forex trading, we realize that there’s more to the system than we realize. The cryptocurrency market is ridiculously slow and this does not allow for any form of delay. Even with the most sophisticated arbitrage cryptocurrency bots, the exchange might have a couple of pending trades and this will amount to increased risk.

2. API integration is a Herculean task

The first issue is that there’s no universal definition for what an exchange API is able to do. We also have very vague details on what kind of data it returns. Actually, this shouldn’t have posed a challenge if documentation was exacting. Those that aren’t will prove difficult to understand, especially when it comes to the rates, how different data types are handled, the different rates, authentication, etc.

3. Exchanges are a cause for concern

It might interest you to know that you can easily set up a digital cryptocurrency exchange from the comfort of your home. With a Raspberry Pi and Ethereum, you can get started immediately. Also, prevalent DDOS attacks and matching engines which operate above their threshold threaten the success of cryptocurrency arbitrage.

There’s obviously a large market for cryptocurrency and it keeps expanding by the day. As cryptocurrency arbitrage bots become more sophisticated, the opportunities can be leveraged more and this will eventually lead to a more buoyant crypto market.

Cover image via u.today
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