If you have been keen about the crypto industry, you have probably noted the seemingly obvious price differences between the various crypto trading platforms that exist today.
Interestingly, price variations for even the most liquid cryptocurrency seem to occur across separate trading platforms.
Most likely, you have always wondered whether such differences may bring about financial opportunities across different crypto markets and digital assets.
Well, crypto arbitrage is a trading technique employed by users to exploit price differences across various exchanges for profit.
For instance, while the Bitcoin price may be $10,000 at Kraken, it may be sold for $9,900 by another crypto exchange like CoinMama, or even slightly lower elsewhere.
Over time, investors have noted the commercial benefits that would arise when they put this specific kind of knowledge to use. A trader may decide to buy Bitcoin at CoinMama and send it to Kraken for sale – thereby making a $100 profit.
Certainly, massive profits are realized when traders deal in massive volumes of digital currency.
Nonetheless, the practice of crypto arbitrage is risky because of the industry’s volatile nature. Traders must make quick decisions to take advantage of the typically small buying-and-selling windows as the gaps are not known to last very long.
The combination of speed and proper timing is imperative to traders, often referred to as arbitrageurs, who have successfully earned big money in the past.
The Basics: Crypto Pricing
You may be wondering how crypto exchanges make money off user transactions. A number of observers have argued that such trading platforms depend on speculative value that is determined by non-tangible market aspects. – That is, virtual currencies are not backed by actual money or precious materials.
On the other hand, other experts argue that the value of cryptocurrency is sufficiently back by user willingness to transact in digital assets. Quite obviously, both schools of thought hold water in the context of demand and supply for the various digital coins in existence.
At the very micro level, crypto exchanges price crypto based on buy orders and sell orders. In a typical trade, a trader would make a “buy order” to purchase one Bitcoin for $10,000.
If a different trader will be willing to sell their Bitcoin for the same price, an exchange will take place after recording on the “sell order” book. Ultimately, the most recent price, which will be determined by the buy order and sell order books, will represent the specific coin price set by a particular crypto exchange.
Types and Limitations of Crypto Arbitrage
At a high level, regular and triangular arbitrage describe the two main methods that are used by traders to buy and sell crypto assets.
Regular arbitrage occurs when an arbitrageur sticks to a specific cryptocurrency while operating across different cryptocurrency exchanges. On the other hand, triangular arbitrage refers to the practice of exploiting price differences between three digital coins within the same trading platform.
For instance, a series of conversions may be used by a trader to purchase Bitcoin with the U.S. dollar, which would then be followed by the arbitrageur’s action to sell the Bitcoin in exchange for Ethereum before its final conversion back to the U.S. dollar.
Nonetheless, a few issues exist in the context regular arbitrage. First, even as price windows occur in a matter of seconds, traders may find it hard to work with speed – the transfer of coins between exchanges and other trading platforms may take minutes, it offers limited opportunity for decision making.
In addition, while triangular arbitrage is not affected by variations in transfer fees, regular arbitrageurs may find it costly to withdraw, deposit, and network between select crypto exchanges and crypto markets.