Crypto arbitrage is a low-risk trade that involves buying a coin on one exchange and selling it on another exchange for profit. For beginners, it’s one of the easiest ways to make money. In this article, you’ll learn all about crypto arbitrage and how it can be a powerful strategy for making money.
What is Arbitrage?
Arbitrage is a form of trading where you take advantage of the difference in prices of an asset on different exchanges. It’s a popular strategy in traditional finance and is considered low-risk. Here’s a detailed explanation on why crypto prices differ across exchanges. So, with crypto arbitrage you’re taking advantage of the different prices of cryptocurrencies on exchanges.
Still confused about how crypto arbitrage works? Well, let’s talk about Bayo – a crypto trader.
- Bayo notices that the price of 1 Bitcoin (BTC) on Quidax is $1,000.
- But, he also finds that 1 BTC on Binance trades at $1,100.
- So, Bayo quickly buys 1 BTC on Quidax and sends the money to his Binance wallet.
- Then, he sells it on Binance and pockets a sweet $100 profit.
Voila! That’s how crypto arbitrage works. Since there are thousands of crypto exchanges in the world, Bayo has many chances to make money from arbitrage.
Why are Crypto Exchange Prices Different?
You’re probably wondering how two exchanges can have different prices for the same coin. Well, this is caused by something called “market inefficiency.” Market inefficiencies happen when a cryptocurrency isn’t bought and sold at its fair price. It can be caused by things like the prices people set on the exchange’s order book, human error, etc.
Unlike traditional assets like cash, cryptocurrencies aren’t really regulated. This means they don’t always have a set value. Instead, their prices are determined by how much people are willing to buy and sell them.
Cryptocurrency Exchanges value a coin based on the most recent price it was bought and sold. This means if $10 is the most recent price someone bought a cryptocurrency on an exchange, the exchange would place the value of that coin at $10. It’s the major reason why exchanges can sell the same coin at different prices.
Here’s a short explainer on why crypto exchange prices vary.
Why is Arbitrage a Low-Risk Crypto Trading Strategy?
Crypto arbitrage is considered low-risk because traders don’t need to predict how a coin would act in the future. Unlike other forms of trading, market trends don’t affect profits as much.
Traders also don’t need to carry out technical and fundamental analysis before buying a coin. They only need to monitor exchanges and spot the price gap between them.
This is also why it’s one of the easiest strategies for beginners to make money in crypto. But this doesn’t mean crypto arbitrage isn’t risky at all. Traders need to be quick at spotting the price gap before it closes. They also need to consider the transaction fees across the different exchanges.
How Does Crypto Arbitrage Work?
Traders monitor coin prices across several exchanges to spot the price difference. Some traders even use bots to increase their chances of spotting the gap. But, there’s more to crypto arbitrage than monitoring the price of a coin. Here are 3 things you need to keep in mind:
- The Coin’s Liquidity
Liquidity measures how easy it is to convert a cryptocurrency into cash or other cryptocurrencies without affecting its value. For arbitrage trading, you have to choose a coin you can easily buy and sell on an exchange.
- The Timing of The Trade
You need to be super quick when trading between two exchanges. Price gaps between exchanges close very fast, and you need to move fast so that you don’t lose money.
- Transaction Fees
Traders deal with different fees when trading. There are trading fees, withdrawal fees, and more. All of these could affect your profit. The best way to bypass this charge is by holding different cryptocurrencies (especially stablecoins) in the exchanges you’re using. But, keep in mind that you will probably still need to pay some fee or the other.
Can I Track the Prices on Exchanges?
You can track crypto exchange prices using price alerts and we’ll show you a neat little trick that could help you stay on top of the market. But, let’s not jump ahead of ourselves. First, you need to understand price alerts and how they work. A price alert is a feature that can let you know when a coin you set hits a specific price.
For example, Bayo could set an alert to let him know when Bitcoin gets to $25,000. This way, he doesn’t always have to sit in front of his screen monitoring the market. On Quidax, you can also set alerts that help you know ‘everytime’ a coin hits the price you want. This helps to you see how volatile the coin is.
A volatile coin is one that moves up and down several times within a given period. This means that people are buying and selling it continuously so the price will change quickly on multiple exchanges. Secondly, it allows you to take advantage of low prices
To set a price alert, to do is go to your profile page and click on “Price Alerts”. Choose the coin and price you want and click on “Set Alert”.
Types of Crypto Arbitrage
There are different types of arbitrage strategies used to make money in crypto. The 5 most common of them include:
1. Exchange Arbitrage
This is the simplest and most common type of arbitrage strategy. In this method, a trader takes advantage of the price difference between 2 exchanges.
In our above example, Bayo uses exchange arbitrage. He buys BTC from Quidax and sells it on Binance for a higher price. Easy peasy.
2. Spatial Arbitrage
This is when a trader takes advantage of the price difference between 2 exchanges in different countries.
For example, a trader based in Nigeria can buy a coin that’s in high demand in Nigeria for a lower price on an American exchange. Then, he sells the coin for a higher price in Nigeria.
3. Triangular Arbitrage
In triangular arbitrage, you deal with 3 different cryptocurrencies. Let’s see how it works using QDX, ETH, and BTC.
Bayo, our trusty crypto trader, has QDX in his crypto wallet. He finds that he can get more QDX if he buys it with BTC on Quidax. He also sees that he can get more BTC if he buys it with ETH.
How does he connect the dots? To maximize his profit, Bayo decides to:
- Buy ETH with his QDX
- Use the ETH he bought to buy BTC
- Use his new BTC to buy QDX again
With this strategy, Bayo would end up with more QDX than he originally had without spending extra money.
Another difference between this type of arbitrage and the other types is that it happens on the same exchange. With triangular arbitrage, you don’t need to worry about transaction fees.
4. Decentralized Arbitrage
To understand decentralized arbitrage, you first need to understand decentralized exchanges. There are two types of crypto exchanges: centralized and decentralized exchanges
– Centralized Exchanges
These are crypto exchanges that use a middleman to match buyers and sellers to each other. This middleman takes the form of an order book.
An order book is a feature that lists the prices of available coins and matches buyers and sellers that have the same interests. If you want to sell 1 ETH for $100, an order book will match you to someone willing to buy your 1 ETH for $100.
Examples of centralized exchanges are Quidax, Binance, Coinbase, etc.
– Decentralized Exchanges
These are crypto exchanges that directly connect buyers and sellers to each other. Instead of an order book, a liquidity pool (also known as an automated market maker) is used by traders to exchange coins.
For example, if you want to sell your ETH, you need to find a liquidity pool that allows you to change your ETH to another coin of your choice.
Examples of decentralized exchanges are Uniswap, Sushiswap, etc.
Now, let’s get back to decentralized arbitrage. Decentralized arbitrage happens when traders take advantage of the price difference between two liquidity pools. For example, a trader can notice that the ETH in a BTC/ETH liquidity pool is valued at a lower price than the ETH in an ETH/LTC liquidity pool. He can then buy ETH from the BTC/ETH pool and swap it for ETH in the ETH/LTC pool.
5. Statistical Arbitrage
This is the use of data analysis to find price differences and trade across exchanges. In some cases, traders could also use bots.
Since it’s automated, traders can make multiple trades at once. But, this is a really advanced form of crypto arbitrage trading and it’s mostly used by experienced traders.
The Risks of Arbitrage
While crypto arbitrage is a great way to make money from the market, it’s also not risk-free. Some of the risks involved here are:
1. Execution Risk
This is a fancy term used to describe a trade not going smoothly because of bad timing. As we mentioned earlier, the differences in coin prices don’t last long. If you make a trade after the gap closes, you may lose your profit.
Imagine you want to buy 1 BTC for $1000. You place your order on the exchange and wait for it to be fulfilled. But, instead of 1 BTC for $1000, you get 0.9 BTC when the trade ends. This is what traders call “slippage.”
Traders are at risk of slippage if the price they want to buy a coin drops during the transaction. It is another effect of price volatility.
3. Liquidity Risk
We explained that liquidity is the ease at which a coin can be exchanged for cash or other cryptocurrencies. If it gets more difficult to convert a coin to cash or other cryptos, it’ll be almost impossible to carry out your trade. To prevent this, always choose coins and exchanges with high liquidity.
Not all exchanges are secure. When you move coins between exchanges, your crypto wallet is at risk of getting hacked. This is why you should only trade on trusted exchanges like Quidax – especially as a newbie trader.
5. Transaction Fees
Exchanges charge different fees for withdrawing, depositing, and carrying out a trade. It’s important to track how these fees may reduce your profits.
Crypto arbitrage is an easy way to make money from crypto as a beginner. As long as you understand how crypto arbitrage works, the risks involved, and how to avoid such risks, you can make money as a crypto trader.
There are tons of ways to make money from cryptocurrency and we even covered 20 of them in our article on how to make money from crypto. But arbitrage is one of the most beginner friendly ways to get started in crypto. Before jumping into arbitrage, the following will arm you with enough knowledge to make the best decisions.
- Learning the basics about crypto trading like we teach in our free 10-minute crypto beginners course.
- Doing a ton of research. Don’t know where to start from? Here’s our simple guide to doing your own crypto research.
- Signing up on a reliable exchange that gives you the option to buy or sell a cryptocurrency in seconds. On Quidax, we have a price alert feature that you can use to monitor the prices of crypto even when you’re sleeping, relaxing, or partying. No need to check your screen a million times.
Quidax is a great starting point for everyone. We keep things simple, fast, and fresh so hit the button below to get started.