Cryptocurrency arbitrage attracts numerous experienced traders and newcomers due to its positioning as a risk-free and straightforward way to earn profits. It does not require technical or fundamental analysis, and the initial capital can be of any amount, with income being almost instantaneous.
Table of Contents:
- What is Cryptocurrency Arbitrage?
- Types of Arbitrage
- Structure and Algorithm of Arbitrage Strategies
- Scanning Tools: What to Use?
- Understanding P2P Arbitrage: Key Aspects
- Best Exchanges for Arbitrageк
What is cryptocurrency arbitrage?
Arbitrage enables both regular traders and large market makers to generate profits. This type of activity is common across all markets. The main characteristics of arbitrage as a trading method are:
|Low-risk transactions||Theoretically, it is possible to achieve profits with no risk since the purchase and sale occur before the price has a chance to change significantly.|
|Speed||Prices in the cryptocurrency market change very rapidly, so arbitrageurs must execute trades within a matter of minutes or seconds. Often, this activity is automated.|
Typically, the profit from arbitrage amounts to a small percentage (rarely exceeding 5-10%), which is why conducting a large number of transactions is necessary to achieve significant gains.
The foundation of cryptocurrency arbitrage is price disparities (gaps) that occur on different platforms or trading pairs due to differences in demand and supply. Each trading pair and exchange constitutes a separate market where prices are independently formed. Arbitrageurs capitalize on these disparities, generating profits from the differences in exchange rates.
From a market perspective, arbitrage is considered a favorable activity that helps minimize price gaps and maintain a stable average asset price. Stable prices on modern centralized exchanges would be impossible without the presence of professional arbitrageurs.
The history of cryptocurrency arbitrage began in the early stages of the market's existence, characterized by low liquidity, a limited number of trading platforms, and fragmented capital. The price difference of BTC on individual platforms could reach several tens of percentage points due to the absence of major market makers and variations in demand and supply. Here are a few well-known examples:
- Enormous price gaps on African cryptocurrency exchanges in 2017. For instance, on the Golix platform, the price of BTC was 87% higher than the average on other centralized exchanges. This was caused by the financial isolation of the region and high demand driven by inflation in local fiat currencies.
- The BTC premium on the Japanese market, which existed until 2018. The high cost of Bitcoin on local platforms was a result of most foreign exchanges not being able to operate within the country. Alameda Research, later launching FTX, managed to grow through BTC arbitrage.
- The "Kimchi Premium": the difference in cryptocurrency prices on Korean and global crypto exchanges. The reason was similar to the case with Japan - strict regulatory rules for international platforms. The "Kimchi Premium" still exists but is not as significant as before.
Before the appearance of professional market makers and substantial institutional capital, arbitrage opportunities were accessible to regular traders. However, after the bullish market of 2017, the more profitable arbitrage on centralized exchanges shifted into the hands of market makers who can respond to gaps faster through automation and trade more effectively on an international scale.
In the early days of decentralized exchanges (DEX) and DeFi, ordinary users also had the opportunity to earn through cryptocurrency arbitrage by trading between centralized exchanges and DEX or various liquidity pools/platforms. However, currently, the majority of arbitrage transactions are carried out by bots that can track transactions even before they are processed.
Types of Arbitrage
There are several types of arbitrage depending on the scale of the transaction and the number of involved platforms:
On-Exchange Arbitrage: Deals are executed on a single exchange but on different trading pairs. The main advantage of this method is speed, as there is no need to transfer cryptocurrencies between platforms, and buying and selling can take just a few seconds.
Inter-Exchange Arbitrage: Involves buying an asset on one exchange and selling it on another. This method is more complex, as it requires having accounts on both platforms and transferring funds between them, which may involve additional fees and time delays.
International Arbitrage: Arbitrage deals involving trading platforms in different countries, as well as local payment methods and fiat currencies. This is the most complex type of arbitrage, as it requires more platforms and assets, making its execution more challenging.
It's also worth mentioning Decentralized Exchange (DEX) arbitrage, which differs from other types of arbitrage and relies on liquidity pools, slippage, asset prices in different networks, and even transaction sequence in the mempool. This is a broad topic that we'll explore in a separate article.
Structure and Algorithm of Arbitrage Strategies
In practice, arbitrageurs use arbitrage strategies, which determine where and at what price to buy and sell assets to profit from price differences. The simplest arbitrage strategy looks like this:
- Buy BTC at price X on the Binance P2P platform.
- Transfer BTC to the Bybit exchange.
- Sell BTC on Bybit at price Y.
However, in practice, arbitrage strategies can be more complex, involving up to 10+ intermediate trading pairs and platforms. They may also include the use of foreign fiat currencies or a combination of exchanges on centralized (CEX) and decentralized (DEX) platforms.
Completing all the actions in a strategy is called a "round-trip." The profitability of a strategy is evaluated as a percentage of the invested funds, which can be earned after completing one round-trip. For example, if the return is 10%, it means the trader can earn 10% of their deposit in one round-trip. The goal of a strategy is to use the profit from the previous round-trip in the next one, gradually increasing the deposit and profit amount.
Arbitrage in cryptocurrencies provides the opportunity to find favorable price differences and trade on them, creating synergy between different markets.
It is important to note that arbitrage strategies are characterized by their short-term nature. Once a strategy becomes well-known or is discovered by a major market participant, the price difference begins to shrink. As the use of the strategy increases, supply and demand balance out, leading to decreased profitability.
The main task of an arbitrager is to identify imbalances in different markets and establish arbitrage connections. To achieve this, traders use bots, scanners, or regular data aggregators.
Scanning Tools: What to Use?
Scanners are tools that help traders discover arbitrage opportunities by analyzing and aggregating price data across different markets. Here are some popular sources of information:
- Cryptorank: This data aggregator offers a dedicated "Arbitrage" tab on the page of each specific cryptocurrency. This tab displays price differences when trading on different platforms. Cryptorank is one of the most convenient and free tools for tracking arbitrage connections.
- Coinmarketcap: Provides a comprehensive list of markets for each cryptocurrency, enabling traders to track price differences across various trading pairs and crypto exchanges.
- Dexscreener: Allows tracking liquidity pools for selected pairs or coins, thereby identifying exchange rate differences in these pools. It's important to note that these pools might be hosted on different decentralized exchanges (DEX) and even on different networks.
Manually monitoring price disparities and creating trading pairs require significant effort and time, which are scarce resources for arbitragers. Hence, many traders use scanners that automatically or semi-automatically detect trading opportunities. Some examples of such services include Coingapp, Arbitragescanner, and ArbiTool.
The functionality of such software may vary based on whether they are paid or free. Free versions usually provide only information on trading directions and may send notifications to social networks, whereas more sophisticated software uses trading bots and APIs for immediate execution of identified trading opportunities.
These tools enable traders to quickly find potentially profitable opportunities and build efficient arbitrage connections based on price analysis across different markets. However, it's essential to remember that the effectiveness of arbitrage connections may change over time as market conditions and competition also evolve.
How P2P Arbitrage Works: Key Aspects
One interesting type of arbitrage is peer-to-peer (P2P) arbitrage. The main characteristic of trading on P2P platforms is the negotiated price between the participants of the transaction. This means that a direct deal may have a price different from the market price.
In comparison to traditional centralized exchanges, where prices are determined based on supply and demand, P2P trading provides participants with greater flexibility and the ability to directly agree on prices. This allows investors to more effectively exploit price differences between different platforms or markets.
P2P arbitrage is a strategy aimed at benefiting from such price differences. The process typically involves several steps. Firstly, the arbitrageur looks for assets traded on different P2P platforms and analyzes the price differences between them. Then, the arbitrageur buys the asset at a lower price on one platform and simultaneously sells it at a higher price on another platform. The price difference becomes the arbitrageur's profit.
However, it's important to consider that P2P arbitrage comes with certain risks and limitations. Firstly, the arbitrage process can take time, especially during asset price instability or delays in transaction execution on platforms. Secondly, the availability of assets and trading volumes on P2P platforms may be limited, making arbitrage opportunities more challenging. Additionally, there are security and legal risks associated with participating in P2P trading and arbitrage.
Overall, P2P arbitrage is an intriguing strategy that can offer opportunities for profit by exploiting price differences on peer-to-peer platforms. However, before deciding to engage in P2P arbitrage, careful consideration of the risks, limitations, and legal aspects related to this type of trading is necessary.
Best Exchanges for Arbitrage
When choosing platforms for arbitrage, it's essential to consider the scale of your operations and the type of platform (CEX or DEX). Often, the most significant price differences occur between pairs on well-known exchanges and less popular platforms, so registration may be required on the following exchanges:
To get a full list of exchanges, you should first explore potential arbitrage opportunities for the selected assets. For example, you can use the "Arbitrage" section on Cryptorank, where exchanges eligible for arbitrage are displayed.
Additionally, automated arbitrage software only supports specific CEX and DEX platforms. If you plan to use such a tool, the list of platforms for registration will be available after downloading and launching the application. In other words, registration on exchanges should only be done after analyzing the market, finding common pairs, and studying the platforms you'll be working with.
A general rule for professional arbitrageurs is that the more accounts they have, the more potential connections they can make.
However, it's not always easy to register on an exchange and go through the KYC process, especially when dealing with closed local platforms or lesser-known exchanges. Finding a balance between the number of accounts, the complexity of registration, and the efficiency of their use is crucial.
Cryptocurrency arbitrage is a method of profiting from asset price differences across different markets. This strategy offers a fast and relatively low-risk way to trade on multiple exchanges simultaneously. Overall, arbitrage helps strengthen the cryptocurrency market by reducing capital fragmentation and ensuring stable average cryptocurrency prices.
In the early stages of the cryptocurrency market, arbitrage was accessible to regular users and provided opportunities for earning even with small capital amounts. However, currently, this niche is mainly occupied by professional market makers and trading bots that can efficiently and promptly fill price gaps better than most traders.
Nevertheless, opportunities for profiting from arbitrage still exist. To do so, an arbitrageur must possess advanced skills in information research and analysis and have the ability to manage multiple accounts and wallets on centralized and decentralized platforms. Therefore, conducting independent research and being prepared for challenges are essential.