What is Arbitrage Trading?
Arbitrage trading is a trading method that cashes in on the differences in the price of a cryptocurrency in different exchanges at the same time.
For instance, consider the price of a cryptocurrency like Bitcoin; $8,000 on the Coinbase exchange, but $8,100 on the Binance exchange at precisely the same time. A trader may decide to capitalize on the price imbalance by purchasing the asset from Coinbase and immediately sell it for a higher price at the Binance market.
Why is there a disparity in pricing of the same currency in different markets? One may wonder. Markets are dynamic. A particular exchange with a limited supply of a given currency will trade the currency at a higher price. A similar market with higher volumes will price it a bit lower.
Methods used in Arbitrage Trading
Traders use different strategies to profit from arbitrage trading:
This strategy involves purchasing and selling the same cryptocurrency on different markets in the shortest time possible to profit from the price imbalance of the two markets. Also known as the regular or spatial arbitrage. The decentralization inherent in the blockchains makes the price differences possible.
Several conversions in the same market involving three different currencies with price disparities are called triangular arbitrage. For instance, you can buy ETH with euro, sell ETH to LTC, and change LTC back to euro. However, the price margins must lead to an arbitrary advantage. The conversion is still possible on multiple markets.
This strategy uses mathematical forecasts based on trading algorithms to capitalize on any expected changes in prices.
Challenges of Arbitrage Trading
In theory, arbitrage of crypto assets seems so easy. However, there are several hurdles you’ll need to overcome to trade profitably. These are some of the risks you may encounter during the trade.
Due to the insanely high number of transactions in the crypto exchanges, there are always many delayed transactions. Moving funds from one platform may take a lot of time before the funds arrive on the next. In that hold-up, the price difference may disappear. Your profits will also vanish.
Many crypto exchanges will charge fees on deposits, withdrawals, or other procedures. If the trader does not factor these expenses in the arbitrage, they may end up eating all of their profits.
Theft in exchanges
You will need to store virtual currency on a cryptocurrency exchange in anticipation of an opportunity. There’s a downside, though. News of hacked platforms and theft of customers funds are unfortunately not uncommon.
With hundreds of crypto markets and exchanges, there’s room for quick and profitable arbitrage possibility. However, for arbitrage trading, it’s all about speed!
There have been negative reviews on slow BTC arbitrage transactions as compared to ETH. It will be safer for a trader to consider using ETH, whose transactions are faster. Also make sure to buy and sell with reliable exchanges to avoid losing your money.
Managing the risk is the elephant in the room. With a plethora of likely threats that could lead to losses in the trade, always take precautions by arbitraging with an amount that you can afford to lose.