Crypto Arbitrage

What is crypto arbitrage?

Cryptocurrencies like Bitcoin are traded on hundreds of various exchanges, and the price of a coin or token on one exchange may differ from that on another. This is when the old Wall Street tactic of "arbitrage" comes into play. "Capturing the arb" refers to profiting from the fact that an asset is selling for a low price in one market but for a greater price in another.

Using crypto arbitrage, investors take advantage of the fact that a digital currency is trading at a lower price on one exchange by buying and selling it for a greater price on another exchange nearly instantly. Here's a closer look at how crypto arbitrage works, as well as several trading strategies that employ it.

What is direct arbitrage?

Direct arbitrage involves trading virtual currencies across two different exchange platforms. This type of arbitrage is a straightforward way of conducting crypto arbitrage.

While direct arbitrage is a straightforward strategy for profiting from price differences, it exposes traders to risks such as transfer delays and costs.

What is direct arbitrage without transferring?

Some traders strive to avoid the dangers that direct arbitrage poses in terms of transfer costs and timeframes. In a hypothetical scenario, they might go long Bitcoin on one exchange and short Bitcoin on another, then wait for the values on both exchanges to converge.

This eliminates the need to move coins and tokens from one platform to another. Trading costs, however, may still apply.

What is triangular arbitrage?

On the same exchange, triangular arbitrage takes advantage of pricing discrepancies between multiple pairings of cryptocurrency. An investor uses this approach to buy one cryptocurrency and then trade it for another cryptocurrency on the same exchange that is undervalued compared to the first.

The investor would then exchange the second coin for a third cryptocurrency that is overpriced in comparison to the first. Finally, the investor would exchange the third cryptocurrency for the first, completing the circuit with a little more money.

How do algorithms help in crypto arbitrage?

At first glance, cryptocurrency arbitrage appears to be as simple as checking for price differences on one exchange and then buying and selling on the other.

In 2017, a famous instance occurred when the price of Bitcoin on Kraken was $17,212, but only $16,979 on Bitstamp, giving an arbitrage opportunity. By purchasing Bitcoins on Bitstamp and quickly selling them on Kraken, an investor may possibly make $233 per Bitcoin.

While Bitcoin spreads aren't typically as wide as in the example above, there are instances when other, less well-known kinds of cryptocurrency can offer even wider differences. Because cryptocurrency values vary from exchange to exchange, arbitrage possibilities for cryptocurrency investors can arise, with thousands of cryptocurrencies trading on hundreds of exchanges.

Investors can use a variety of apps to watch the values of Bitcoin and other cryptocurrencies for arbitrage possibilities. This allows investors to take advantage of algorithms that search for arbitrage across many crypto exchanges automatically. This automated strategy could allow crypto-arbitrage traders to profit from a variety of price differences.

What are the dangers of crypto arbitrage?

Losses

To be successful in crypto arbitrage, investors must execute trades fast in order to profit from cryptocurrency price disparities across exchanges while they are still profitable.

A trader must be careful not to boost the purchase price and decrease the sale price of a digital asset by their own trades, especially in the thinly traded types of crypto that provide the widest spreads.

Volume

The crypto exchanges all work in the same way, pricing crypto depending on the exchange's most recent trade. It's crucial to remember, however, that not all trades are made equal. Some of them trade massive amounts of money, while others aren't as busy. The liquidity and accessible prices on a given exchange are influenced by the trading volume on each.

Low volume could indicate that the exchange is unable to execute a trade large enough to generate the profit that an investor desires. Low volume could also indicate that the trade is doable but will take too long to execute.

Transaction Costs

Simultaneously, traders must keep a watch on the transaction fees associated with buying cryptocurrencies on different trading platforms. These fees will continue to fluctuate as the cryptocurrency markets develop, changing from exchange to exchange.

Taxes

The IRS has established a tax guide that categorizes cryptocurrencies as property in the United States, where bitcoin usage has soared in recent years. The Securities and Exchange Commission has classified cryptocurrencies as a type of security, while the Commodity Futures Trading Commission has classified them as a type of commodity.

The IRS treats cryptocurrency income in the same manner that it considers gains from the sale of real estate. With this in mind, investors must account for any capital gains taxes on their federal income tax returns, although they may be allowed to deduct losses.