Cryptocurrency arbitrage trading: how it works and why you need it

Every day, millions of transactions change hands for tens of billions of dollars worth of cryptocurrencies. But unlike traditional exchanges, there are dozens of cryptocurrency exchanges, each showing different prices for the same cryptocurrency.

For experienced traders - and those who aren't afraid of a little risk - this opens up an opportunity to gain an advantage: to play these exchanges against each other. Welcome to the world of crypto arbitrage.

What is crypto arbitrage?

Arbitrage is a trading strategy in which an asset is bought on one market and immediately sold on another at a higher price, using the difference in price to make a profit.

Crypto-arbitrage is self-explanatory; it is arbitrage using cryptocurrency as the asset in question. This strategy uses the different value of cryptocurrencies on different exchanges.

On Coinbase, bitcoin can be priced at $10,000 and on Binance it can be priced at $9,800. Taking advantage of this price difference is the key to arbitrage. A trader could buy bitcoin on Binance, transfer it to Coinbase and then sell it, making a profit of about $200.

Speed is key in the game. These breaks usually don't last long. But the profits can be huge if the arbitrageur calculates the market correctly. When Filecoin appeared on exchanges in October 2020, some exchanges listed a price of $30 in the first few hours. Others, on the other hand, listed $200.

Different types of arbitrage

Inter-exchange arbitrage

One method of crypto-arbitrage is to buy cryptocurrency on one exchange and then transfer it to another exchange, where the currency is sold at a higher price. However, this method has several problems. Spreads usually exist within seconds, but transfers between exchanges can take several minutes. Transfer fees are another problem, as transferring cryptocurrency from one exchange to another incurs fees, whether it be withdrawals, deposits or network fees.

Triangular arbitrage

This method involves using three different cryptocurrencies and exchanging on the difference between them on one exchange. Since everything happens on the same exchange, the transfer fee is not an issue.

Thus, a trader can see arbitrage opportunities involving Bitcoin, Ethereum and XRP. One or more of these cryptocurrencies may be undervalued on the exchange. Thus, a trader can take advantage of arbitrage opportunities by selling his bitcoin for Ethereum, then using that Ethereum to buy XRP, and then buying back BTC with XRP.

Statistical Arbitrage

Statistical arbitrage involves using quantitative data models to trade cryptocurrency. A statistical arbitrage bot can trade hundreds of different cryptocurrencies simultaneously, carefully calculating the probability that the bot can profit from a trade based on a mathematical model, and opening a "long" or "short" trade. This is the stratagem that 3commas trading uses in its algorithm, which allows them to be one of the best cryptocurrency bots on the market.

DeFi arbitrage

Decentralized finance, or DeFi, refers to non-storage financial protocols that work without human intervention, like lending protocols, stackablecoins and exchanges. Their code-rich architecture makes them ideal for arbitrage.

It is also possible to profit from other trades. If a DeFi trader sees a great opportunity, he may want to place that trade as quickly as possible to make his money. But the bot may pay a little more to have his trade processed first. By moving to the top of the queue by paying a higher gas fee, the trading bot could make a little extra money.