What is Crypto Arbitrage, and How Does It Work?

Delton Rhodes
Delton Rhodes
What is Crypto Arbitrage, and How Does It Work?
Table of Contents
Table of Contents

Learn everything you need to know about crypto arbitrage. This blog post contains info about various types of trading techniques and tools as well as potential risks.

For traders looking to start arbitrage trading crypto, there are a few key differences between arbitrage trading in other markets. However, the basic concept is the same. Being successful involves finding low prices for an asset or group of assets and selling that same asset or group of assets for a higher price to net a profit.

How Do Crypto Prices Work?

Crypto prices can fluctuate quite a bit from exchange to exchange. On Coinbase, one Bitcoin (BTC) might be worth $57,000, while simultaneously worth $57,300 on AtomicDEX or $57,100 on Binance. Cryptocurrency exchanges show prices based on the most recent trade. If a user on AtomicDEX, for example, sells BTC at a price of $57,400, this would move the price up to that amount. Likewise, if the selling price is $57,200, then the price of BTC on this specific exchange goes down. This is true regardless of the amount being sold. Oftentimes, exchanges will use data feeds from trusted providers or decentralized trustless oracle (DTO) solutions to show the average latest market prices. Ultimately, however, it’s up to the traders on a particular exchange to become makers and takers on each side of the trade and agree upon a specific buy/sell price.

Bitcoin Markets
You can check real-time prices across hundreds of exchanges and countless trading pairs on sites like CoinMarketCap.

How Does Cryptocurrency Arbitrage Work?

Exchange Arbitrage

Exchange arbitrage is one of the easiest ways to start crypto arbitrage trading. This is done simply by crypto trading simultaneously on two different exchanges. Various exchanges have withdrawal waiting times and fees, so it’s nearly impossible to catch crypto arbitrage opportunities by using the same funds twice. A more practical way is to hold an equivalent amount of funds on two different crypto trading platforms.

Let’s say you have 1 BTC (worth $57,000) on Exchange A, and 57,000 USDC (worth 1 BTC) on Exchange B. Let’s say the dollar cost for 1 BTC suddenly falls to $56,800 on Exchange B but only falls to $56,900 on Exchange A. You can immediately create market orders on both exchanges to net $100 in profit. Of course, you also have to consider any trading fees charged by both exchanges when deciding whether or not to place simultaneous trades.

Statistical Arbitrage

Finding crypto arbitrage opportunities on your own and successfully executing the trades may be difficult, but thankfully there are plenty of trading bots that use mathematical models to trade on your behalf and make profits. Some bots are able to trade hundreds of digital assets at once to optimize for every possible scenario. While many advanced statistical arbitrage trading crypto bots charge fees either monthly or per trade, there are also free options available. One crypto bot from Pionex, for example, supports futures-spot arbitrage trading. Superalgos offers a free and open-source option for creating your own bots. As far as paid bots go, many offer free trials so you can try them before committing to a long-term solution.

Futures-Spot Arbitrage
Pionex offers a futures-spot arbitrage bot that enables traders to earn 15 to 50% APR.

Triangular Arbitrage

Although more complex to execute manually, there is a way that arbitrage crypto traders can make profits by just using one exchange. This can be done via triangular arbitrage. In basic terms, this strategy involves three cryptocurrencies. For instance, a trader could sell Bitcoin (BTC) for Zcash (ZEC), then use that Zcash (ZEC) to buy Dogecoin (DOGE), before finishing by buying Bitcoin (BTC) back with Dogecoin (DOGE). If arbitrage exists between these pairs, the trader will likely gain more Bitcoin (BTC) than someone who chooses to HODL in their non-custodial wallet.

Decentralized Finance Arbitrage with Yield Farming

Decentralized finance (DeFi) is an area of crypto arbitrage that became popular in 2020. Better known as yield farming, various platforms like Yearn Finance enable users to automatically find arbitrage opportunities on DeFi lending protocols. For instance, if a user can gain 10% on DAI on Platform A and 15% on USDC on Platform B, yield farming automates the process of gaining yield on the more profitable platform. The protocols find the crypto arbitrage, while the user relies upon the security of smart contracts. DeFi arbitrage is quite risky as smart contracts often have bugs either by design or by accident. Many experimental platforms have offered high yields and failed to provide a long-term sustainable option for arbitrage seekers. One notable is Yam v1, which offered a 10,000 percent APY then suddenly crashed. The total market cap of the project’s coin dropped from over $130 to less than $1 in the span of a day after a contract bug was uncovered.

Crypto Arbitrage Calculator

If you’re wondering how you can get started without having to use bots or yield farming protocols, there are a few videos online (such as this example here) that show you how to make a basic yet effective crypto arbitrage calculator using an Excel sheet. All you need is a basic understanding of how to use APIs and add simple formulas.

Cryptocurrency Arbitrage Risks & How To Avoid Them

Yes, crypto arbitrage can be very profitable. However, you should be aware of the potential risks involved that might impact your ability to make profits.

Check the Coin Name & Ticker

For example, DIA (DIA) and Dai (DAI) might appear to be the same coin when not looking at names and tickers carefully enough. However, DIA is an ecosystem for open financial data, while DAI is a USD-backed stablecoin. Sometimes the names of two coins are different but the tickers are the same. Examples include FairCoin (FAIR) & FairGame (FAIR), Propy (PRO) & ProChain (PRO), among others. Even more confusing is that a lot of ERC-20 tokens built on the Ethereum blockchain have the same coin names and tickers, but different token contract addresses. This leads to even more confusion if both are listed on popular exchanges where you want to trade. The easiest solution is generally to check sites like CoinMarketCap and CoinGecko to monitor real-time prices and trading volumes. Doing this research makes it easy to decipher which coin is which.

Compare Exchange Fees + Understand Asset Management

If you want to start arbitrage crypto trading using a centralized exchange, it’s a good idea to be aware of any fees before depositing your coins. While most centralized exchanges don’t typically charge deposit fees, many charge high trading fees or withdrawal fees. This creates a lock-in situation, where most users who do arbitrage crypto trading keep their coins on the exchange in order to avoid paying high fees. As a best security practice, it’s better to take funds off of centralized exchanges to avoid possible security breaches. Decentralized exchanges (DEXs) offer a more secure way of arbitrage trading crypto since they don’t have deposits/withdrawals, meaning they can’t charge high fees. DEXs are also more secure since they enable you to have 100% control of your private keys and non-custodial wallet, meaning you have full ownership of your coins.

Withdrawal Fees
Many centralized exchanges charge high withdrawal fees for certain cryptocurrencies.

Don’t Buy Into Promises Of Unreal Returns

You might have heard the classic crypto scam that goes something along the lines of, “Send me one Bitcoin, and I’ll send you two back.” Unfortunately, a few people still fall for this in one form or another. For example, Crypto Arbitrage VIP was a website that promised 340% returns and presented itself as a Bitcoin doubling service with legitimate payouts. The site has since been taken down, but arbitrage seekers should be cautious of services that are similar to this. Crypto arbitrage trading, nor any form of trading, leads to instant, insane profits. If something sounds too good to be true, it probably is.

Ensure The Target Trading Pair/ Market Has Adequate Liquidity

Before trading, it’s important to know whether enough coins exist in the order books. If the exchange doesn’t have sufficient liquidity or no one is trading the trading pair(s) you’re targeting, you might miss out on some opportunities. Sometimes this isn’t just the case on a few exchanges. It may be the case across the board, especially for low-cap coins. So while the price difference between exchanges might appear enticing on the surface, arbitrage crypto trading strategies should factor in the size of the market.



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