There is no doubt that many of you have heard of cryptocurrency arbitrage, and have probably even wanted to conduct financial deals on such popular exchanges as Binance or Bitfinex.
In this article, Applicature will reveal what Bitcoin arbitrage is in reality, how it works, and how to benefit from peaks in the crypto market.
The word arbitrage itself implies a fair deal. However, upon checking any economics-related dictionary, you will find out that arbitrage actually means taking advantage of price variance on different markets.
The principle is quite simple: let’s say that Bob wants to benefit from a Bitcoin price variance, and buys 1 BTC on crypto exchange A. Now that he owns 1 BTC, he looks over other exchanges, where the price is higher than the price he bought it for and sells when he finds the one.
There are several different variants of arbitrage trading:
- Space arbitrage. This type of trading refers to conducting deals in different markets at the same time. This method was described in the previous paragraph about Bob holding 1 BTC.
- Time arbitrage. Trading the same funds in the one market in order to take advantage of price fluctuations; this is what time arbitrage is. However, it can’t be performed simultaneously, unlike space arbitrage.
Because time arbitrage is closely connected to price prediction, it turns out to be much more complicated to perform. Therefore, trading cryptocurrency in different markets is easier and brings about fewer risks.
Space or cross-exchange arbitrage is gaining benefit from an exchange/broker/financial system through quoting inefficiency. Consequently, buying crypto for a lower price on one exchange (or from another trader/broker) and selling it for more money, a trader makes his/her profit. This is the reason why arbitrage trading is so widespread now.
Let’s review some cross-exchange trading schemes more precisely and analyze their differences.
Cross-Exchange Trading Schemes
A general explanation of arbitrage describes this type of trading quite simply; however, even the plainest deals can have pitfalls and disadvantages. Applicature will reveal all of these in order to prevent future traders from making mistakes.
Going back to the example with different prices on two exchanges: Bob buys 1BTC for $10,000 U.S, and sells the same 1BTC on another exchange for $10,500 U.S. As a result, Bob’s profit is $500 U.S; however, this is a so-called “dirty margin,” which, when turned into a “profit margin,” will be considerably lower. Here’s why:
It only sounds that simple: buy cheap, sell for more. In reality, crypto exchanges also need to profit, so traders pay fees for the actions they do on an exchange:
- transferring money from the outer wallet to the exchange storage
- depositing money (this point refers only to certain exchanges, like HitBTC and Bitfinex)
- buying crypto on exchange A
- transferring money between two exchanges
- selling crypto on exchange B
- withdrawing money from the Exchange B.
Obviously, there is no use trading Bitcoin if the cross-exchange spread (the difference between Bitcoin quoting on two exchanges) is lower than 2%. This is why people who trade consider the fees and work on different schemes that help reduce transaction fees.
The issue of liquidity is definitely one of the most crucial elements when conducting arbitrage deals. Due to the fact that a high level of cross-exchange spread mostly takes place among low-liquidity altcoins with low trade volume, big deals are also difficult to accomplish.
Professional arbitrage dealers predominantly work with cryptocurrency in big amounts, which helps decrease transaction costs.
Additionally, it’s worth mentioning that a lot of dealers are chasing arbitrage profit at the same time. So, with a considerable price difference between two platforms, assets will be bought quickly. Therefore, a dealer may lose his/her profit.
Price Change Risk
All actions for cross-exchange arbitrage should be done concurrently, as there is a high probability of spread or quoting. Change in these factors can make the deal detrimental.
Most frequently, the risk described above arises when money transfers from one exchange to another. The reason for delay could be technical work being done by the development team, or blockchain overload.
The main problem in arbitrage trading scheme #1 is the requirement for fast money transfers. In scheme #2, Applicature reveals the way to get rid of this issue.
Let’s imagine that Bob owns 100 ETH and 4 BTC, and stores them on two exchanges in 50/50 proportions in order to spread the risk.
Step 1. Bob buys 50 ETH on one exchange (for the BTC he has on the same exchange).
Step 2. Bob sells his 50 ETH on another exchange.
Step 3. Bob makes two money transfers between two exchanges in order to balance the funds.
This arbitrage approach is more likely to serve in the long-term perspective rather than for instant profit.
Disadvantages of Scheme #2
- Limited mobility. Bob is tied to two exchanges and has to wait until a convenient moment that promises a profit.
- High transaction fees. After the buy-and-sell operation, Bob will need to make two money transfers to balance out the funds. He will have to pay extra fees.
Scheme #3: Intra-Exchange Arbitrage
There is also the possibility of making a profit on a single exchange in the following situation:
As a result of conducting this scheme, the dealer will get a $500 USDT profit minus transaction fees.
This kind of scheme can have more than three assets; however, the longer the process, the higher the fees.
Disadvantages of Scheme #3
The meanest enemy of any arbitrage deal is the possibility of a fast quoting change. If the targeted coin prices go down, the deal can even cause financial loss.
Bitcoin Arbitrage Opportunities
Crypto exchanges have differences in price due to the fact that markets are not linked directly, and very often, prices can differ by a percentage. However, if several traders use the opportunity to profit from this difference, the prices emerge. Then the risk of playing a losing game pops up.
In order to find the best available rate on the market, there is Challengly, acting as an intermediary between crypto exchange and a user, that selects the best crypto trade and makes the process effortless for those investing in crypto.
The coin of the most popular blockchain development company Bitcoin and its exchange arbitrage opportunities are tracked in different communities. One of them is SFOX Trading on Twitter, where the dealer states how much others could earn from exchange pairs:
As we see from the screenshot, there is always an opportunity to earn money on price volatility. However, would $37 U.S. cover all fees, and would the price stay the same within the time frame of the arbitrage deal? It’s very unlikely to be a good deal to depend on unless the dealer has a team or a bot that conducts buying and selling and operations on different exchanges simultaneously.
There are some circumstances that dealers have to take into account. Arbitrage dealers should consider that putting fiat in an exchange wallet would take one to three days. If he/she works with a foreign currency, moving fiat from the exchange to an international bank would take other several days. Moreover, the deal should be big enough to cover all fees.
Let’s imagine that exchange A offers Bitcoin for a 0.40% higher price than an exchange B. Bob wires fiat from his wallet to exchange A and buys Bitcoin. He will have to pay 3 fees: a transactional fee for wiring fiat, a network fee, and a trading fee.
Then he moves his BTC to the wallet on the exchange B, and for this, he will have to pay another 2 fees: a network fee and a withdrawal fee (the same he pays when trading BTC on exchange B).
When the profit seems to be in his pocket, Bob has to exchange BTC to USD, and wire them back to his bank account, however, this will also cost him fees: a withdrawal fee, a wire fee, and a foreign exchange rate fee.
Eventually, Bob loses .8% of the money he initially put in his wallet., The Bitcoin arbitrage “opportunity” doesn’t consider the risk of the price going down on exchange B. It is essential for the Bitcoin blockchain development company and its coin’s arbitrage dealers to consider that cryptocurrency prices fluctuate constantly. Rates can go up and down several times within one minute.
As you can see from the Coindesk Bitcoin price report, the rate went up by $160 USD in only one hour. In the case of a drop in price, this could drastically change the outcome of an arbitrage deal.
Bitcoin Arbitrage Strategies
Conducting arbitrage deals can’t be considered a risk-free business in terms of price volatility and delays, so the Applicature blockchain development company will share strategies that will help dealers calculate and minimize the risks.
If you see a certain profit and want to invest and earn on a crypto exchange (like Bob from our example), you will need to buy and sell without waiting until the money comes into your wallet on the exchange. In order to not lose the deal, you will have to keep money in your wallet at the exchange from which you want to engage in arbitrage.
One of the most famous Bitcoin arbitrage strategies is keeping the same amount of fiat and BTC on two exchanges concurrently. By following this strategy, the dealer won’t lose time wiring money; he/she will instantly buy BTC on exchange A and sell it on exchange B (scheme #2).
Checking through the top crypto exchanges will definitely provide Bitcoin arbitrage opportunities; however, checking order books will show even better results.
Order books are real-time lists of rates of all cryptocurrencies that reveal the gap between supply and demand. This is a Bitcoin arbitrage tool that connects all markets on one page. Let’s review an example of a Bitstamp order book:
Bids and asks are shown in pairs that result in a trade if both sides meet the requirements.
The Most Popular Arbitrage Websites
The order book is one of the most convenient Bitcoin arbitrage tools. It collects and shows data on cryptocurrency rates and puts orders to buy (bids) or sell (asks) in a list on different exchanges. This is the exact case we will talk about in this chapter: Bitcoin exchanges.
Applicature lists the top 5 exchanges that are worth your attention.
Launched in July 2017, this China-based trading platform has already been hacked. Instead of making the project go down, this only made it stronger and more popular.
The trading fee on Binance stands at 0.1% of the transaction sum, and withdrawal fees vary. Binance also boasts high liquidity and multi-language support.
Binance supports over a hundred of successful cryptocurrencies; however, unlike Coinbase, it doesn’t support fiat currencies, which means traders can only hold cryptocurrency on Binance.
A San-Francisco-based crypto-trading platform, Coinbase is one of the most popular Bitcoin arbitrage tools among traders.
Coinbase is famous for its high liquidity and instant-buy feature. It supports top cryptocurrencies such as BTC, BCH, ETH, LTC, ETC, ZRX, BAT as well as over 50 fiat currencies.
Trading on Coinbase can become quite costly in terms of on-platform fees. The deposit fee for a bank transfer is 1.49%, a wire transfer is $10 U.S, and a USD wallet would cost a dealer 1.49%. In terms of withdrawal fees, bank transfer and wallet fees are the same; however, the withdrawal fee is higher, at $25 U.S.
Coinbase is a digital cryptocurrency exchange. Coinmama, another famous platform for buying and selling crypto, is a cryptocurrency marketplace.
The exchange boasts a huge number of customers (over 200,000), and both BTC and ETH buy-and-sell opportunities. In addition, it supports some of the most successful cryptocurrencies: ETC, BCH, LTC, ADA, QTUM, and XRP. However, the only fiat currencies available on Coinmama are USD and EUR.
While Coinbase limits its deposit methods with only credit and debit cards, Coinmama sustains deposit opportunities for debit and credit cards, SEPA, and even cash.
There is no withdrawal fee; however, transfer and deposit fees are much higher than on Coinbase: 5.90% for trading and 5% for deposits.
There are many crypto exchanges on the market that offer the same services and provide subtle differences. One popular exchange that is similar to Coinbase and Binance is Bitstamp.
This is a digital cryptocurrency exchange, but it isn’t famous for adopting a lot of fiat or cryptocurrencies: EUR, USD; BTC, BCH, LTC, ETH, or XRP.
Bitstamp allows payments in a limited number of currencies, but not deposit methods: if a dealer wants, he/she is able to pay with a credit or debit card, bank transfer, cryptocurrency, or a wire transfer.
Bitstamp, like the majority of trade platforms, charges a trading fee that fully depends upon how active a user is as a trader, judging from his/her 30-day history.
Even though Bitstamp is a young exchange, founded in 2017, it has a limited number of altcoins, unlike Kraken — the old-timer of cryptocurrency exchanges.
Kraken is one of the oldest crypto exchanges, and it is also one of the most trusted. For instance, in Japan, Kraken is regulated by the government, even though the exchange is based in the USA.
Kraken is a sophisticated platform for professional traders. It supports up to 20 of the biggest cryptocurrencies on the market as well as five fiat currencies: USD, EUR, GBP, JPY, and CAD.
One of the biggest disadvantages of Kraken as a trade platform is its set of limitations in terms of deposit methods: it allows only electronic payments plus bank and wire transfers.
Despite the disadvantages mentioned above, there are several advantages users can expect to encounter when entering any crypto exchange. Kraken is trusted and has low fees. Proof of the trust granted to Kraken can be found in the fact that the Japanese government and European banks regulate it.
Bitcoin Arbitrage Obstacles
Bitcoin arbitrage deals seem so simple to conduct to earn an easy profit, so why isn’t everyone in the world doing it? Well, cryptocurrencies are not regulated by all countries, so crypto exchanges need to meet some of the requirements before everybody can use them:
One of an example of obstacles caused by KYC (Know Your Customer) regulations is the need to own a bank account in the country where the exchange is based. Also, to start trading, the account should be verified, which usually takes a bank about a day.
To avoid waiting until the money is wired to an exchange, and to be able to use it as soon as there is a profitable arbitrage deal, users should be aware of the risks connected to storing currency in an exchange wallet. There have been multiple hacks of even the biggest and safest crypto exchanges, which means promising safety doesn’t mean providing it. However, there is one recommendation that Applicature can give to traders in order to protect their money: keeping money in cold storage.
As became clear from the review of the most popular exchanges described earlier, a lot of trading platforms charge high fees for any action taken on the exchange. This makes trading a costly process, which leads to the next obstacle.
Big deals required
On exchanges that charge high fees, traders will have to search exclusively for big deals in order to profit from them; otherwise, they will hardly break even.
Crypto exchanges are big fish for hackers, and founders of cryptocurrency marketplaces try to do everything to protect users from loss. This is why some exchanges limit daily withdrawals. On the one hand, a hacker will not be able to take more than the daily limit; on the other, it causes some inconveniences for users who conduct high-volume deals.
The most important requirement in arbitrage trading is to execute a deal in time. Buy-and-sell actions take time, during which the price can drop or go up due to its volatility. This is especially true for cross-exchange trades. This is why most dealers trade stable coins, developed by Bitcoin and Ethereum blockchain development companies.
In order to minimize the risks connected to arbitrage trading, Applicature has listed below the actions that must be taken for funds protection:
- Research. Check all possible lists of cryptocurrencies and their features to stay updated and calculate profit with regard to currency perspectives.
- Choose cryptos with higher transaction speed. Comparing BTC and ETH, Bitcoin is often accused of transaction delays and slow transactions. Ethereum offers faster transactions, which will minimize the risk of not being executed in time.
- Plan all your actions. With regard to market volatility, traders should always stick to a certain plan or strategy in order not to avoid losing their profit.
- Rely only on trustworthy exchanges. Use crypto community chats such as Reddit to track the latest reviews of exchanges that exist on the market. Monitoring the crypto market will help you stay up to date and find the most profitable deals. We recommend these ones:
- Don’t store all money on one exchange. The best advice that one trader can give to another is not to stake more than you can lose. This doesn’t refer to the risk of being hacked, but it will speed up cross-exchange deals.
Legal Aspects of Bitcoin Arbitrage
When interest in a certain arbitrage trade rises, it leads to merging prices. This is not just legit, it benefits the entire market. In most countries, Bitcoin arbitrage trading is legal, though a number of countries claim it to be illegal — predominantly due to the fact that these countries don’t have any regulations on cryptocurrencies. This makes trading cryptocurrencies less than legal.
Unlike the U.S. and Japan, which allow crypto exchanges, India has claimed Bitcoin to be illegal and, correspondingly, Bitcoin arbitrage, as well.
Interest valuation arbitrage within DeFi development companies is related to the exploitation of interest rate differentials between DeFi platforms. DeFi/CeFi arbitrage endures when there is a difference in interest rates in centralized and decentralized platforms. Conversely, carry-trade tactics can be applied, i.e. you can take out a loan against an asset with a low-interest rate to invest in an asset that brings bigger profit.
Although, all current DeFi platforms and DeFi development companies depend on excessive collateral obligations from the borrower’s perspective, which restricts the arbitrage possibilities.
In both DeFi and CeFi platforms, there are numerous possible market weaknesses that can be attributed to the following causes:
- the emergence of new blockchain solutions for DeFi (weak liquidity as evidenced by leverage and daily transaction volumes (relative to CeFi);
- platform-related uncertainties: interest scale volatility, possible challenges with smart contracts, ambiguity in loan negotiation, repayment jeopardies, etc.
After all, as the DeFi development companies develop, it is expected that there will be fewer new opportunities. Interest rates for different platforms should also be the same if the assets and platforms have similar dangerous aspects. However, novel platforms and protocols such as interest rate swaps can bring a wider spectrum of dealing possibilities.
Bitcoin arbitrage has turned to be a great opportunity for gaining a margin in a short amount of time with almost no effort, but it does carry a lot of risk. One of the biggest risks is that of not executing in time, which occurs most frequently when conducting cross-exchange trades that take time to transact.
Additionally, arbitrage traders must keep in mind the fees that exchanges charge. In order to break even, traders should choose high-volume deals.
The risk of being hacked doesn’t fade away when an exchange offers the most reliable security features, so traders should always take extra security measures to protect their funds. One recommendation to help enhance protection of funds is to keep currency in cold storage.
According to CoinMarketCap, there are 227 crypto exchanges on the market, and the number is constantly growing. However, only a few of them are credible. Exchanges recommended by Applicature include: Binance, Coinbase, Coinmama, Bitstamp, and Kraken.
Should you have any remaining questions regarding crypto investment, blockchain solutions for DeFi, purchase or sale, exchanges, or building business based on the blockchain, the Applicature blockchain advisor team is always ready for productive communication and cooperation.