Arbitrage in trading refers to a strategy where traders capitalize on the price differences of the same asset across different markets at the same time. This strategy is particularly relevant in the crypto space due to the high volatility of digital assets and the significant fragmentation of the global blockchain ecosystem, which is reflected across various trading platforms. For example, Bitcoin often reaches local all-time highs in specific countries or even on certain platforms, even if its global prices are far from record highs.
Beyond its speculative nature, arbitrage plays a crucial role in balancing market prices, serving as a self-regulating mechanism. However, since price differences are often minimal, traders must execute large-volume transactions to achieve significant profits, making arbitrage one of the riskier trading strategies.
Types of Cryptocurrency Arbitrage
Arbitrage can be conducted on any type of trading platform: CEXs and DEXs, trading platforms, protocols, brokerage services, payment services, trading bots, crypto exchanges, and more.
Intra-Exchange Arbitrage
This type of arbitrage is possible within a single trading platform if it offers a wide range of trading functionalities. For example, on some crypto exchanges, you can buy coins in the spot market and sell them via peer-to-peer (P2P) transactions at a higher rate.
Intra-exchange arbitrage can also involve using intermediate trading pairs on one exchange. One popular method is triangular arbitrage, where profits are made by exploiting the price spread between three different assets, such as BTC-ETH, ETH-USDT, and USDT-BTC pairs.
The spread refers to the maximum difference between the buying and selling price of an asset at any given time.
Inter-Exchange Arbitrage
This type of arbitrage involves using two or more trading platforms where the prices of the same asset differ. It’s one of the most common forms of arbitrage. The basic algorithm for conducting inter-exchange arbitrage transactions includes:
- monitoring asset prices in various trading pairs across different platforms;
- identifying trading pairs with significant price differences;
- buying the asset at a lower price on one platform, transferring it to another platform, and selling it at a higher price.
Inter-exchange arbitrage can also involve international arbitrage, which entails transferring funds through banks in different countries. This process may involve crypto exchanges and fiat money transfer services between countries. Arbitrage specialists must consider currency exchange rate differences and transaction fees associated with all operations.
Funding Rate Arbitrage
Funding rate arbitrage is a specific trading strategy used in the markets of perpetual crypto futures. Unlike traditional futures, perpetual futures have no fixed expiration date. To keep the price of a perpetual contract close to the current market price of the underlying asset, a funding mechanism is used.
The funding rate is the automatic redistribution of funds between traders with long and short positions. When the perpetual futures price is higher than the spot price of the underlying asset, the funding rate is positive, and traders with long positions pay a fee to those with short positions. When the funding rate is negative, the reverse occurs. These payments involve various variables and are calculated using complex formulas that can differ by platform.
Funding rate arbitrage involves hedging perpetual futures positions by opening opposite trades in the same trading pair in the spot market. The profits and losses of these positions offset each other, but the trader can earn from the funding payments, which include the funding fee and a premium calculated separately for each contract.
Tools for Cryptocurrency Arbitrage
To simplify and automate arbitrage operations, various types of software are employed, generally categorized into three main categories.
Scanners
These programs monitor crypto prices across different platforms and instantly highlight profitable arbitrage opportunities. Scanners are usually subscription-based. Free versions or free scanners may have delayed information updates, increasing arbitrage risks, or they may limit the spread level in displayed opportunities, often excluding those with potential profits exceeding 1%. Examples include Spreadscan, Cryptohopper, P2P.Army, ArbiSmart, among others.
Screeners
Screeners display crypto prices on various exchanges. Unlike scanners, they don’t provide ready-made arbitrage opportunities but allow traders to set up a watchlist of cryptocurrencies for monitoring and analysis. Popular screeners include DEX Screener, ScalpStation, and Messari. They typically retrieve data via APIs from major aggregators like TradingView, CoinGecko, and CoinMarketCap.
Arbitrage Bots
The pinnacle of arbitrage trading automation is represented by arbitrage bots. These algorithms react to price fluctuations faster than humans and can monitor the crypto market 24/7, reducing risks and increasing potential profits. Trading robots autonomously track opportunities and execute trades. Arbitrage bots are often used for triangular arbitrage within a single exchange but can also perform inter-exchange arbitrage. Effective use of these bots requires personalized configuration, calibration, and operator oversight. Popular arbitrage bots include TriangularArbitrage and Bitcoin Dealer.
Risks of Cryptocurrency Arbitrage
Obviously, arbitrage yields profit when the difference between the buying and selling prices exceeds the fees associated with asset movements and conversion. Another crucial factor is the volume of circulating capital — higher volumes lead to greater potential profits but also increased risks.
The primary risk is the possibility of price changes during the trading operation, particularly when transferring assets between platforms. Delays can arise due to various factors affecting transaction speed, including:
- technical glitches and platform limitations;
- transaction queues due to blockchain network congestion;
- trader’s personal delays, etc.
Additionally, arbitrageurs may face losses from transaction blocks. To mitigate these risks, it’s essential to choose reputable trading platforms that provide:
- fast deposit and withdrawal processing;
- high level of market depth;
- regulatory compliance;
- prompt technical support.
Moreover, there’s a risk of falling for fraudulent projects. It’s crucial to thoroughly vet all counterparties, especially before executing large transactions.
Significance and Future of Cryptocurrency Arbitrage
Cryptocurrency arbitrage plays a pivotal role in the crypto ecosystem, influencing its growth and development. Here are some key aspects of crypto arbitrage:
- Market efficiency. Arbitrage enhances the efficiency of cryptocurrency markets by equalizing prices across various trading platforms, thereby addressing price discrepancies.
- Liquidity. Active participation by arbitrage traders boosts liquidity in individual markets, making them more attractive to investors.
- Technological innovation. The rise of high-frequency automated trading based on algorithmic strategies improves the possibilities for crypto arbitrage, making it more accessible and effective, and fostering the overall development of the blockchain industry.
Overall, digital asset arbitrage remains a crucial aspect of crypto trading, closely linked to technological advancements and the further evolution of the crypto market. However, it’s important to remember that crypto arbitrage carries significant risks, and success in this area requires a deep understanding of the market, technical aspects of trading, risk management, and psychological resilience.
