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There are so many ways to earn from the substantial opportunities the cryptocurrency provides. Some of these ways include trading, buying, and selling as the price fluctuates and other opportunities.
Arbitrage is a form of trading cryptocurrency that involves buying and selling in different markets due to market price fluctuations for a profit.
There are over 1000 cryptocurrencies available in the world, and each provides a different solution to the world or an existing cryptocurrency network. Hence, with this high number of cryptocurrencies comes in considerable ways to make a profit.
With the risk trading brings, it still tops the list of the top ways most people make a profit from the cryptocurrency market. Trading relies on the market’s volatility; therefore, the cryptocurrency market is a perfect ground for a good trader.
How can you make a profit from trading? Trading can be a very dangerous zone for new traders as it requires good knowledge of the market plus proper money management skills.
So many professional traders have categorized the money management aspect of trading as an unteachable one; it is an involuntary action. It is a subconscious action we take no matter how much we try to learn; therefore, it develops as we grow in trading, which is why you see so many professional traders recommending the Demo trading accounts for new traders.
The demo trading account assigns virtual cash to new traders, with this they can practice what they have learned as well as develop their money management skills
What Is Cryptocurrency Arbitraging?
Traders work with so many strategies to make a profit; some of these strategies include range trading, news trading, arbitrage, and others. You must have probably come across arbitraging in so many recent online posts, but can you explain to a four-year-old child what it is all about.
What is arbitrage? As you can guess already, arbitrage is a trading strategy used by traders to make a quick profit.
The prices on different market can sometimes vary, for instance, the price for metal on the foreign exchange market is $10 while the price for the same stock (metal) in the local exchange is $12; if this is noticed by a trader, this can be one of the simplest ways to make quick profit through trading.
You simply have to buy on the market where the market is low and sell on the other market where the price for the same stock is high.
So in an elementary term, arbitrage is buying on one market and selling in the other market due to variation in the price of both markets. However, take note that three things are constant with arbitrage, the same stock, and also, it must be a quick and swift buying and selling process.
With the understanding of the concept of arbitrage, what is cryptocurrency arbitrage?
It is basically the same thing as the regular arbitrage concept but now applied to the cryptocurrency market.
However, in the regular currency or forex market, there has been the development of systems that are specially built to track the variation in price across exchanges and carry out trades has made it harder for individual traders to make use of arbitrage.
The cryptocurrency trading market is a new developing one and, as such, provides opportunities for arbitraging due to a rapid increase in trading volume as well as deficiencies amongst exchanges. As a result of this causes market price variations.
Cryptocurrency exchanges with larger liquidity control the prices of the other smaller markets; therefore, smaller exchanges don’t often update the prices of cryptocurrencies from broader markets.
With this variation in price between the higher markets and the smaller ones, it presents the chance for arbitrage.
How Does Crypto Arbitraging Work?
Cryptocurrency arbitraging works with the variation in the market price of cryptocurrency exchanges.
Crypto arbitraging is made possible because cryptocurrency with high liquidity and volume of cryptocurrencies offer them at lower prices while exchanges with the limited supply of the same cryptocurrency will associate a high price with it.
So to explain this in a more straightforward and less twisted way, we need to take a step back to basic laws of supply and demand in economics.
When the supply for a commodity is high, but the demand is low, the price is low, while if the request is high and the supply is low, the price is high; this is what is called scarcity.
If you understand the theory of demand and supply then, let’s take it to cryptocurrency, cryptocurrency exchanges are platforms where you can buy and sell cryptocurrencies.
The amount and type of cryptocurrency offered on each cryptocurrency differ, which means, you have to select the exchanges that allow trading of your chosen cryptocurrency for crypto arbitraging.
Liquidity of the market talks about how available the cryptocurrency is in the exchanges, exchanges with high liquidity control the price of the cryptocurrency market, and exchanges with smaller liquidity offers buying and selling of the cryptocurrency at a higher price.
So crypto arbitraging can work in two ways, you buy from market liquidity due to the low price and sell on a market with low liquidity.
Also, due to the time, it takes the smaller exchanges to update the prices of some of the cryptocurrencies.
For instance, market A sells bitcoin for $ 500 per token, but market B sells the same bitcoin for $450 per token; you simply have to buy from market B and sell in market A, leaving you with a gain of $50.
Types of crypto arbitrage?
There are two types of crypto arbitrage, which are:
1.Arbitrage between Exchanges
This is the most common and widely used type of crypto arbitrage. The adoption of this type of crypto arbitrage is due to the similarity to the forex arbitrage model.
Crypto arbitrage between exchanges, just as the name implies, only requires you to track differences in price between exchanges and make a profit from there.
Few factors have to be considered to be able to identify the best crypto arbitrage opportunities between exchanges, some of the factors are:
The time-zone of the exchange you choose to perform arbitrage on can be a significant factor to consider. Based on geography, you need to find out the times when it is easier to buy and sell during the time of the day.
Due to liquidity, prices generally fluctuate on smaller exchanges or new exchanges than the larger ones.
The liquidity of exchanges is basically affected by the law of demand and supply; the higher the demand, the higher the price, and the higher the supply, the lower the price.
On big crypto exchanges, the supply is high; therefore, the price tends to be moderate while on the smaller or new crypto exchanges, the demand is high, but the supply is low, leading to an increase in price.
How can you benefit from crypto arbitrage between exchanges?
Register on both exchanges
The first step to take to partake in arbitrage is to register on both exchanges; the larger exchange and the smaller one.
Variation in price between exchanges will not last till forever; therefore, it requires prompt buying from one and selling on the other.
Some exchanges might require the KYC verification, which requires you to verify your identity with a valid identification document.
After registration, you should register for an online wallet on both exchanges. Wallets are storage where cryptocurrencies are kept.
Deposit cash on the exchange with the lower price and transfer to the other exchange
You will need to make a quick purchase of the crypto on the exchange with the lower price and transfer to the other.
Purchasing a cryptocurrency requires you to pay with fiat or another crypto based on the payment mode accepted by the crypto exchange.
After purchase, transfer from the wallet of the exchange with the lower fee to the wallet of the other exchange.
Sell the cryptocurrency on the exchange with the high price
Sell the transferred cryptocurrency on the second exchange for fiat, leaving you with a profit of the price variation. However, your profit might not be the difference in price due to the charges associated with depositing and withdrawing on exchanges.
Withdraw your profit
The last and the best stage of the whole process is to withdraw your profit. This is the part everyone wants to know about, not the process of how it was achieved.
The amount of profit you make will depend on the volume of cryptocurrency you arbitraged and the charges on withdrawing and trading. So, the profit from arbitraging can differ from person to person.
Note that the process of conducting arbitrage between exchanges can be affected by some factors.
The first is the charges associated with depositing and withdrawing; you should work with a cryptocurrency exchange that charges little or nothing for depositing or withdrawing.
You don’t want to use up all your profit to pay for depositing, withdrawing, or trading fee.
The second obstacle is the time it takes to transfer between exchanges.
Transfer between exchanges can sometimes take five days; this can sometimes be a blessing or curse as the price of the cryptocurrency might increase during this period leaving you with more profit or the price might drop, reducing your gain.
You can avoid or limit the transfer time between exchanges by depositing cryptocurrency and fiat on both exchanges, this way, you don’t have to transfer.
This will save you from the charges associated with the transfer, and also you don’t lose your profit.
2.Crypto Arbitrage within the Same Exchange
If you had thought arbitrage was only possible when dealing with two exchanges, you are wrong. Since there is a lot of cryptocurrency in the market, and the cryptocurrency market is a volatile one, there are price variations between cryptocurrencies.
Arbitrage between cryptocurrencies requires you to buy a specific cryptocurrency and sell for another cryptocurrency on the same exchange and make your profit.
Arbitrage within the same exchange is also known as triangular arbitrage or cross-currency arbitrage. In this type of crypto arbitraging, you are merely trading currencies against one another, and you make a profit through it.
This type of crypto arbitrage is, however, encouraged over arbitrage between two exchanges because it eliminates the charges incurred due to crypto transfer as there is no need to transfer cryptocurrencies. The steps to get started with crypto arbitraging within the same exchange are:
- Deposit fiat on the cryptocurrency exchange
- Buy a certain cryptocurrency X
- Sell cryptocurrency X for another cryptocurrency Y on the same exchange
- Repeat the second and third step for more profit
- Sell the accumulated cryptocurrency Y for fiat
- Withdraw your profit
You should, however, note that the law of diminishing returns will come into play as the process continues; therefore, you should take time to calculate the ratio of risk to reward.
The only disadvantage with crypto arbitrage within exchanges is that the arbitrage opportunities are less evident than in the latter type.
Crypto exchanges are popping up every day.
Here is a list of exchanges that make purchasing crypto easy:
These have been tested and meet our guidelines for Security, Community Trust and Ease of Use.
What are the Obstacles to Crypto Arbitrage?
The following are the common problems you tend to encounter when crypto arbitraging irrespective of the type:
- It takes time to verify the transaction, this is most common with crypto arbitraging between exchanges. During this time, the price of the cryptocurrency might increase or reduce.
- For a large number of cryptocurrencies, most exchanges will require you to additional verification known as Know Your Customer (KYC) to trade. You should have a valid document ready if you intend to arbitrage with a large number of cryptocurrencies.
- You should do thorough research about the crypto exchange to use due to the higher charges associated with some. If you do crypto arbitrage with exchanges with a high deposit, withdrawal, or trading fee, it might consume all your profit.
- There are other factors responsible for price variation apart from liquidation and others, factors such as technical issues and reputation issues. It is important to use reputable and trustworthy exchanges.
Is Arbitraging Illegal?
Arbitraging is exploiting and benefiting from the market inefficiencies with price with different or the same market.
Arbitrage is legal as no crime has been committed during the process, and it also helps the market to improve its efficiency.
In an attempt to gain from the price variation in the market, arbitrage traders in an unknowing way are contributing to the market efficiency.
In the long run, arbitrage will lead to convergence of the price of the asset. For instance, a crypto arbitrage trader buys cryptocurrency from an exchange X and sells it in an exchange Y due to the fluctuation in price.
The profit incurred from this transaction will draw the attention of other arbitrage traders who will also exploit the same opportunity, on the long-run, the opportunity will vanish, and the price of the cryptocurrency will balance across all markets
The second reason why arbitrage is essential in the market is to create a balance in liquidity. In a case where the liquidity of a cryptocurrency is high on exchange X and low on exchange Y, crypto arbitrage traders will use the opportunity of the low price on exchange X and make a profit by selling on exchange Y.
During this process, liquidity is being moved from crypto exchange X to exchange Y, thereby, creating a balance between exchanges.
Therefore, arbitraging is entirely legal; it follows the fundamental law of trading, buying, and selling to make a profit as many traders do daily.
Can You Arbitrage Bitcoin?
Bitcoin is the first cryptocurrency and has the highest market value out of all cryptocurrencies.
Also, it is the most widely accepted and use cryptocurrency in the world; it also experiences more volatility than other cryptocurrencies.
Due to the volatility of the bitcoin, with the ability to lose and increase its value in a short period, it is one of the best cryptocurrency for arbitraging.
Every cryptocurrency is available for arbitraging, in the real sense, it depends more on the cryptocurrency exchanges rather than cryptocurrency.
Arbitraging is an excellent way to capitalize on market fluctuations.
You have to be as fast as these opportunities since they can go away just as fast as they arrive. Be careful as any type of trading can lead to a loss in your investment.
As always make sure you have the proper tools you need to trade successfully. Trusted tools. especially in Arbitraging is important.
By potentially having to bounce from one exchange to another you need to have your security and identity at the top of mind.
Be sure to check out Recommended battle-tested tools for Crypto to make sure you have everything you need to remain safe online.