Cryptocurrency Arbitrage — how does it work?

Cryptocurrency arbitrage refers to buying coins on a digital exchange where the price is significantly lower & simultaneously selling the coin at a crypto exchange where the price is higher, as result, profiting from a difference in prices.

“Regardless where the market moves, arbitrage always makes a profit!”

This is in fact true — if your altcoins don’t tend to really drop or rise by 50% or more within 24 hours. In reality, the digital currencies you tend to trade should be compatible stable, while still showing some degree of volatility — no volatility at all would show a flat line on the chart, resulting in zero opportunities.

Step 1: Find an opportunity

This step is absolutely easy. Simply open another web browser and go to abitrage.expert to find your next arbitrage opportunity. I would also advise checking out the blog Arbitrage section for some detailed how to info.

The article is based on a live trading experiment we had performed over the weekend, using multi price arbitrage between GDAX, Livecoin and Yobit. The pairs we’re going to use are eth/usd; xem/eth; xem/dodge; ltc/dodge; ltc/usd, to attempt to make 4 potentially risk free trades, and ultimately increase our USD balance by 20%

The budget we’re going to set for this example is $1,000. At the end the trip, our balance is $1,200 (+20%). The intention of this post is to give readers the tools and the map to be able to replicate it at home.

• The cryptocurrency market is still very immature in comparison to the traditional stock market, therefore there are plenty of arbitrage opportunities.
• Those with dev automation skills can do exceptionally well in replicating this model.

First of all, here is a bit of info and a few tips where its due.

The arbitrage opportunities and other signals are present 24/7, and can be easily spotted on cryptocurrency arbitrage opportunity app.

Step 2: Execute

TL:DR of the arbitrage strategy:

1. We search for price differences between exchanges with medium to high liquidity (depending on the value being traded). Sometimes, not so liquid market could still do the job, by serving as swapping point. In our example {xem/eth[0.00052191–0.00053965]} isn’t very liquid market, however since only $1k is being traded, we can get away with it.

2. We begin drawing a map by searching for an entry point. In our case its going to be GDAX eth/usd [BID/ASK — $546.17- $546.18] {result = 1.8 ETH}. Second entry point is LIVECOIN : xem/eth [BID/ASK 0.00052191 ETH -0.00053965 ETH] {result = 3,461 XEM}. Followed by YOBIT : xem/doge [105.86760592 DODGE — 112.67738991 DODGE] {result= 363,405 DODGE}. Then, we perform second currency conversion again on YOBIT : ltc/doge [46571.84497627 DODGE — 46900.14599813 DODGE] {result = 7.80 LTC}and finally we transfer LTC back to GDAX : ltc/usd [159.31 USD -159.32 USD] {result= $1,240} and convert it back to USD. Let’s take away the trade/deposit/withdrawal fees.

a. eth/usd — trade fee 0.25% | withdrawal fee — free

b. ETH deposit fee — free; xem/eth — trade fee 0.18% | withdrawal fee — 5 XEM

c. XEM deposit fee — free; xem/doge — trade fee — 0.2% | ltc/doge — trade fee — 0.2% | withdrawal fee — 0.00005 ltc

d. LTC deposit — free; ltc/usd — 0.25%

e. Total trade fees: 1.08%; total transfer fee in USD $1.70

3. The ultimate goal is to be able to take advantage of the multiple arbitrage opportunities, with intention to return the coin back to the original starting point.

At the end of the arbitrage trip and after paying all the trading fees & transfer fees, we were able to generate 20%.

We’ve gone through 4 trades and 3 transfers over 1 hour and 23 minutes to generate $196. It was indeed a semi-risky trade due to low XEM/ETH liquidity. Nevertheless, let’s dig deeper and evaluate some of the nuances from the example above, so you can quickly learn how to do it yourself.

A market risk free alternative to the described strategy would be buying and simultaneously selling a coin on one or more exchanges. However, an equal amount of each currency would be required to be maintained on each associated exchange. Upon successful completion of the transaction, your total balance would rise. I don’t recommend this technique to multiple arbitrage strategy, though it might be useful applying to traditional arbitrage techniques, such as buying on exchange A, and moments later selling on exchange B, without necessary to transfer the coin. This is indeed a great approach, however maintaining wallets full of coin or even fiat across all major exchanges might not be such a good idea.

I personally prefer to aim for higher arbitrage % spread, while assuming the market risk, during the coin transfer period. The average coin confirmation time period is roughly 15–20 minutes for all the major coins (when things run smoothly). If the arbitrage spread is high enough, like in the example above, you run the risk of ultimately generating less, should the market price drop while the coin is traveling.

The multiple arbitrage approach opens a door to opportunities that cease to exist in traditional arbitrage world. Often, folks who promote traditional arbitrage fail to mention the difficulty that may arise, due to hefty fiat withdrawal fees that may totally destroy the arbitrage profit. I always advise not to get in, unless you have an exit plan! Let’s assume you made a simultaneous trade, and now you’re stuck with BTC on an exchange B. What are your options?

1. Transfer BTC back to an exchange A without losing any value. (might be tough to accomplish).
2. Sell BTC for fiat and withdraw the funds. (umm, grr.. the withdrawal fees?)
3. Draw out a multiple arbitrage opportunity map and execute it with precision. Even if a clean 3% spread can be generated from running a multi arbitrage strategy, we will still come out on top, due to rinse and repeat approach.

Most importantly, traditional (simultaneous) arbitrage has very limited opportunities, sometimes you’d have to wait for days before another one pops up. Nevertheless, many factors come to play. Personal risk tolerance, level of aggression and of course desperate thirst for money. The last one usually separates rock stars from an average Joe.

Step Three: Review

Let’s briefly review the steps we took to achieve the maximum arbitrage spread. First and foremost we have to identify multiple opportunities and draw out a road map. Before we proceed, let’s identify some of the key factors we’re going to be looking for.

1. Every entry point, must have a round trip exit strategy.
2. 24 hour Market must be at least 10x more liquid than actual volume about to be traded.
3. If an intra exchange arbitrage spread is present, we look for at least 0.30%.

Arbitrage.expert will soon present a new premium “road-map” feature. It is designed to display multiple round trip arbitrage paths between pairs on various cryptocurrency exchanges. The algorithms is made to make simultaneous API calls to multiple exchanges and retrieve prices on trading pairs. Next, the AI evaluates the data, and displays the best possible step-by-step arbitrage opportunities in user friendly format.

Step Four: Don’t Mess Things Up

Here are some important tips for to follow.

Performing the above steps manually may lead to a couple of mistakes, so it’s crucial you seriously consider some of these things.

1. Make sure to check the buy & sell prices by hand on all exchanges.
2. I advise to check if there is actually enough volume for the price you’re about to buy/sell. Often, a person places an order to buy or sell well above or below what everyone else is buying/selling at the given time, and it only might be for a couple tokens. If you’re looking to sell 1,000, you’d have to look what the best price you could attain:

For instance:

The “Highest Bid” is shown as 0.0005700 but that is just for 120 XEM. If we were to sell 3,461 XEM, we’d likely be selling for a slightly lower amount between 0.0005156–0.00050 . That’s a big difference, and may potentially minimize the overall arbitrage profit. If another exchange is displaying “Best Ask” price as 0.0005700 then you may think that you’ve got a sweet opportunity, but in reality you may not. Please be sure to pay extra attention to this area.

Automation Is The King!

If you can find a smart way to automate the process that I’ve described above, congratulations! You’ve won yourself a lottery ticket. Just kidding. While automating the arbitrage algorithm may sound intelligent and robust, there are still plenty of risks involved.

Traditional Arbitrage Counterparty risk

To strike a profitable arbitrage deal, you will have to store your coins on multiple cryptocurrency exchange websites. Sadly, there are plenty of examples of crypto exchanges being hacked, or some running away with your coin.

There are some decentralized exchanges exist today, like Bitshares or the NXT asset exchange. Unfortunately, the volume is still low, and the non-real time nature of decentralized systems can be a downside for arbitrage trading.

Execution risk

The execution risk minimizes the possibility of having executed the trade on 1 side, but then not being able to fulfill on the opposite side of the trade, because someone has already taken it, or the order was eventually pulled from the market. It’s the risk of someone else being quicker than you, or the market is moving fast enough against your favor.

Price decline risk

In a bear market, the trading funds will decrease in value over time. Even if you striked lots of arbitrage deals, the profit generated may not be nearly enough to mitigate your losses.