How To Earn On Cryptocurrency Arbitrage. The Simplest Scheme
Before we discuss how to earn on cryptocurrency arbitrage, we need to figure out what it actually is. Cryptocurrency arbitrage is a series of transactions performed on different trading platforms in order to profit from discrepancy in asset exchange rates. This is another way to make money on cryptocurrencies, apart from investing and trading.
The strategy of making a profit from buying and selling at different prices is not new and has long been used in the financial market. So we can say that all arbitrage schemes are workable and well-known, although the cryptocurrency market dictates its own terms. The crypto market is very young and dynamic compared to the financial one. Therefore, on the one hand, it may be easier to earn money if deals are closed in time. On the other hand, it is unpredictable, thus cryptocurrency trading involves much more risks.
Types of cryptocurrency arbitrage
There are two main types of arbitrage, depending on the time and place of transactions:
- Convergence, or inter-exchange arbitrage
All buying and selling operations are performed on different crypto exchanges. For example, bitcoin arbitrage between exchanges.
- Simple, or intra-exchange arbitrage
All buying and selling operations are performed within one trading platform.
There are different cryptocurrency arbitrage strategies. The complex schemes are high-risk, thus they are not recommended for novice traders.
Before we consider the simplest strategy of the cryptocurrency arbitrage, it is worth saying why crypto arbitrage is possible. This principle of earnings is based on imperfections of the existing financial system or its participants — cryptocurrency exchanges and exchange services. The easiest way to make money on arbitrage is using local crypto exchanges with small trading volumes, because the difference in rates is more significant there due to underdeveloped connection with other exchanges. However, this method can pose risks, and we will tell about them later.
The simplest scheme of the convergence arbitrage
The easiest way to make money on exchange rate differences is to buy cryptocurrency on one exchange at a lower price and sell it on another exchange at a higher price.
Step by step:
There is Exchange A, where the ETH/USD pair is trading at $1,000.
There is Exchange B, where the same pair is trading at $1,080.
A trader buys 10 ETH for $10,000 on Exchange A, then transfers the ethers to Exchange B and sells them for $10,800.
The difference between the invested and the received amount is $800, but this is not the amount of profit. The real profit will be less, sometimes significantly less. The conditions of deposit, transfer, and withdrawal of funds may vary on different exchanges. You should be aware of these conditions before going for arbitrage.
Pitfalls of crypto arbitrage
Each exchange sets a different amount of fees. To start arbitrage trading, a trader has to complete five operations: deposit funds to Exchange A, buy coins, transfer it to Exchange B, sell, and withdraw. A fee may be charged at each of these steps, it depends on conditions of a specific online platform. Therefore, the amount of fees is the first thing you should take into account when choosing exchanges for arbitrage.
The popularity of coins may be different on exchanges, especially if they are not top crypto assets. If a demand on Exchange B is much lower than on Exchange A, this can be dangerous. In this case, there is a risk to sell cryptocurrency cheaper.
The main rule of successful arbitrage is speed. All operations must be performed quickly, almost simultaneously. Exchange rates change every second, and if a trader is slow, the asset prices may get equal. In this case, the arbitrage doesn't make any sense.
Now you know how to earn on cryptocurrency arbitrage and what main peculiarities such a kind of trading has. But there are more complex schemes and difficulties a trader may encounter. We will discuss them in the next article.