Tricks of the Trade of Crypto Arbitrage

9 September, 2019

With multiple markets having different exchange rates, the price of a coin tends to be volatile. Crypto arbitrage trading gives the perfect opportunity to capitalize on this situation.

If you are familiar with cryptocurrency, you will agree that crypto trading is still in its infancy with various markets spread across the globe. Cryptocurrency arbitrage is a trick which the crypto traders keep up their sleeves to take advantage of the difference in exchange rates.

Traders buy the currency cheaper and sell it off at a higher rate of exchange. This concept sounds enticing, yet there are quite a few pitfalls that you should watch out for prior to engaging in the market.

Now, let’s dive in…

To put it simply, arbitrage means buying and then reselling. You buy an asset on one market and sell on another to make profits from the difference in prices between these two markets.

Crypto Arbitrage is a direct arbitrage. It is made possible by the difference between two separate markets having unequal trading volumes. Usually, a market that has high trading volume is known to have a tight spread when it comes to the liquidity of a particular coin. Indeed, the opposite is true for a market with low trading volume. Such a market would have a much wider spread for the coin due to its limited supply.

Technically, crypto arbitrage aids a trader, for instance, when searching for a coin that is cheaper on Binance than on Bitfinex. When he discovers the opportunity, he buys the coin and sells it simultaneously at a higher price on Bitfinex to get his profit. Interestingly, this concept is not new to the exchange market. The bond, stock, and forex traders are quite familiar with it.

The contemporary cryptocurrency market offers a lot of different arbitrage opportunities. Momentary surges in trading volumes, coupled with certain market inefficiencies result in subtle price differences. Typically, the more prominent exchange with high liquidity controls the prices of a coin. With an arbitrary rise in price at one exchange, others follow suit. However, the response of other exchanges is usually slow, and this is what creates the desired arbitrage opportunity that traders need to make their move.

How Is Arbitrage Trading Carried Out?

One basic approach to cryptocurrency arbitrage is to carry out your transactions manually; keep tabs on the markets for the difference in prices, place a trade and wire your funds accordingly.

Interestingly enough, technology has brought us cryptocurrency arbitrage ‘bots’ that enable you to keep track of the prices in various markets while keeping your hands clean.

Types of Arbitrage

There are a couple different types of spatial arbitrage, with the most prominent ones being:

  1. 1. Arbitrage betting
  2. 2. Triangular arbitrage
  3. 3. Statistical arbitrage

These three arbitrage techniques are most familiar to and practiced widely by the crypto world traders.

Let’s have a closer look at how triangular arbitrage works.

Introduction to Triangular Arbitrage

The scheme shows 3 linked crypto trading platforms (Binance, Bittrex, KuCoin) that form a triangle

The triangular arbitrage, known to some individuals as cross currency arbitrage or a three-point arbitrage involves taking advantage of an arbitrage opportunity created by a price disparity between three different currencies that do not match up exactly.

In triangular arbitrage, three trades are set up wherein there is an exchange of the first currency for the second, the second for the third and ultimately the third for the first. Let me drive this home with a better example. You buy a coin in USD, sell it off to make a profit in EUR and convert the EUR amount back to USD.

It is worth mentioning that a profitable trade is possible only when there are market imperfections, which means that the participating buyers and sellers do not have perfect information at one particular moment in time. The presence of this momentary ‘information asymmetry’ gives birth to its offspring that we know as ‘arbitrage opportunity’.

Triangular arbitrage is a rare arbitrage opportunity, only available to those traders that make use of advanced computer programs to automate the whole complicated process.

Key Facts About Triangular Arbitrage

Here are the key facts you should be aware of before you start crypto trading using triangular arbitrage:

  • It is a form of profit-making venture that helps traders take advantage of the variances in exchange rates by executing algorithmic trades.
  • To make profits, such trades have to be carried out quickly and need to be done in large volumes.
  • Sometimes, the cost can also exceed the profit margin.

How To Calculate Triangular Arbitrage?

For better understanding of the phenomenon, Let’s begin with this simplified example.

Assuming you have a million dollars ($1,000,000) and the following exchange rates are prevalent in the market

  1. Fx1: EUR/USD = 0.80
  2. Fx1: EUR/GBP = 1.4, and
  3. Fx2: USD/GBP = 1.755

Keep in mind that these are arbitrary figures. We can see that the different rates create an arbitrage opportunity.

With all these in place, keep to the following procedure to calculate the triangular arbitrage:

  1. Fx1: Exchange your Dollars for Euros. You will get 800,000 Euros (1,000,000 × 0.80).
  2. Fx1: Following this conversion, sell your Euros for Pounds. This would leave you with 571,428.57 in Pounds (800,000 ÷ 1.4).
  3. Fx2: Now, sell the Pounds for Dollars to get 1,002,857.14 Dollars (571,428.57 ÷ 1.755).
  • When these transactions are completed, subtract the initial investment from the final return to calculate your gross profit earned.
  • In simple words, you receive 2,857.14 Dollars (1,002,857.14 – 1,000,000) as the gross arbitrage profit for this transaction, without considering taxation and other related costs. This is a simplified way of calculating triangular arbitrage.

To further expand our understanding, we can cite another example using crypto. Suppose we buy ETH on Binance and pay BTC on Bitfinex. That will lead us to:

  1. Binance: 1 BTC = 8700 USD = 43 ETH (although this is possible but not desirable, as direct BTC to ETH might give us just 42.5 ETH because of insufficient liquidity)
  2. Bitfinex: 43 ETH would sell for 1.15 BTC.

So we “transferred” assets between the exchanges with some profits.

0.15 is the gross arbitrage profit for this transaction before taking taxes and charges into account.

If this sparked your interest and motivated you to take a plunge into crypto trading, do let us know so that we help you dig deep into the calculation process to make your trading a successful venture.

How To Profit From Triangular Arbitrage

One crucial factor that is paramount to generating profit from this type of arbitrage is knowledge and understanding. Knowledge is followed by computer software, which would automate the process. Knowledge is vital and you need to be well informed to be ahead of competition in this trade.

Honestly speaking, just buying and selling unequal currencies can land you risk-free profits. However, if you are not quick enough in your decision making, chances are that you lose out because any such inefficient pricing is detected by multiple traders and this rare opportunity is often eliminated in a matter of seconds, as traders move in to level-out the information asymmetries.

A person is monitoring the activity on stocks market using 6 monitors

Your most important tool here is the live coin ladder showing the price levels at any given moment. It can be as simple as an Excel spreadsheet with a few columns containing the most significant trading parameters, such as the exchange, the price, and the calculated difference. More experienced traders track other indicators as well, such as the demand, supply, and volume.

At the end of the day, you have over 220 different cryptocurrency exchanges to track, leaving you sitting in front of the screen day and night, having to make vital decisions at a rate that is only attainable by the sharpest of minds. For an everyday trader, it’s much easier to leave all of this to a computerized automated solution.

Also, the price differences (spread) between these exchanges are quite slim. Only traders who have considerable capital for a wholesale level of investment would enjoy this kind of crypto arbitrage. For retail traders having moderate to low funds for investment, the profit will be added but chances are that it might be negligible.

So how do you succeed?

Some Tricks to Help You Out

Doing these extensive and complicated calculations can be quite stressful and exhausting. An efficient way to go is to leave these computations to dedicated arbitrage bots and to let special software solutions do the heavy lifting for you.

The “crypto arbitrage calculator” is one of such tools that is purpose-built to get the job done effortlessly. It provides the retail trader with real-time arbitrage opportunities. Often, these calculators are sold for a specific fee on various sites by third-party vendors. Still, others are available for download free of charge.

Apart from these calculators, other software exist which can be employed in giving you an optimum result. On a cautionary note, we would advise you to first try the software out on a demo account to avoid incurring losses due to faulty and/or overloaded systems.

Furthermore, it would be better to try out multiple solutions before you settle for the best.

Does This Actually Work?

The head of a human that contains numbers and trading graph on the background

A lot of individuals wonder if these things we preach are real at all. Well, we have been in this business for a while, and can state with confidence  ‘they do exist’. One reason people are unable to seize these opportunities is that they are passive investors or are myopic to visualize these momentary chances appearing on the horizon. Triangular arbitrage is very much possible if it is set and executed in a proper environment, although we do agree it is not all that simple. If it were the case, the streets would be littered with millionaires.

Conclusion

This article leads us to conclude that arbitrage is an apparently sophisticated, but inherently plain technique of generating profits by taking advantage of price anomalies in different exchanges or markets. It is worth a reminder that the market prices would be leveled as soon as traders begin to exploit the pricing inefficiencies. Bitfinex might be slow in reacting to the changes already taking place in Binance, but it is certain that it definitely would try to close in on the gap. This is why an active response to the changes is vital to making a profit for anyone going in for crypto arbitrage.

Since arbitrage opportunity is only available for a short period, quick and focused response is the key to success. Arbitrage is a great way to materialize potential profits by efficiently exploiting the exchange rate differences in the currencies involved.

As a potential trader, you must know that there are certain risks involved with cryptocurrency arbitrage which are quite comprehensible. For instance, the KYC (Know Your Customer) regulations ensure that you should have an operational bank account in the same country where the exchange is done, prior to making the trade. So, traders are advised to familiarize themselves with this kind of information before they place a trade.

We have worked with several of our clients to create tailored arbitrage systems to meet their individual needs. For instance, the Arbitrage cryptocurrency trading platform and arbitrage bot is designed to find the most profitable trade options and execute them on behalf of the trader, while avoiding risks and avert exchange losses. The automated platforms are great systems because they make it possible to carry out triangular arbitrage with convenience. An algorithm is created from the group up to execute a trade when certain requirements put in place are satisfied, thus taking the stress off the trader.

According to Forbes, crypto arbitrage was tagged as an astronomical way of getting incredible returns. You are encouraged to give this article a read.