Crypto Arbitrage for beginners: What is it and how does it work (Part 1)
Crypto arbitrage is the practice of buying and selling cryptocurrencies in different markets to take advantage of differing prices. It is a trading strategy that offers attractive rewards at a relatively lower risk.
When done right, arbitrage trading allows investors to make low-risk profits. But as in most speculative markets, this trading strategy comes with risks and complexities. For beginners, it may come with a sharp learning curve.
Learn the basics of crypto arbitrage in this guide.
What is crypto arbitrage trading?
Crypto arbitrage is derived from a traditional currency exchange practice known as arbitrage that dates back to the 18th century. It’s a straightforward practice where you buy currency where it has the lowest price, then sell it to a market where its price is higher.
How does it work?
Cryptocurrencies such as Bitcoin (BTC), Ether (ETH), Litecoin (LTC), and Binance Coin (BNB) have differing prices across exchanges. These coins may exchange higher or lower, allowing traders to earn profits from the price discrepancies. But successful arbitrage trading depends on various factors like liquidity, trading volume, and fees.
Pros of Crypto Arbitrage
Arbitrage trading is a great skill to have to generate income quickly in the crypto sphere. Here are its main advantages:
Investors looking to profit quickly can perform crypto arbitrage. Compared to the traditional practice of buying and holding crypto and selling it at a later date, you can complete arbitrage transactions within an hour or less.
Arbitrage trading is a type of short-term investment, making it less risky than its long-term counterparts. Since you’re exchanging currencies simultaneously, big losses caused by slippage and low liquidity are unlikely.
Arbitrage trading requires volatile markets. In fact, it is the crypto market’s volatility that creates arbitrage opportunities for traders. Compared to other financial markets, digital currencies are being traded 24/7 globally across hundreds of exchanges, giving traders a gold mine of arbitrage opportunities.
For savvy traders, arbitrage can be a worthwhile strategy as it presents a wide range of opportunities. There are over 391 cryptocurrency exchanges in the world that you can tap to leverage price differences.
Cons of Crypto Arbitrage
Although arbitrage trading is considered a low-risk practice, it still involves a number of risks owing to the unpredictability of crypto markets.
Crypto exchanges are notorious for their high transaction fees. You can’t deposit, withdraw, or trade on these platforms without paying a fee. If you perform arbitrage trades regularly, these charges will add up, so be sure to account for the fees when calculating for profit.
A successful arbitrage trade requires great, if not perfect, timing. Since crypto markets are highly volatile, it’s common to lose potential profit in just minutes when the market moves against you. To avoid this, always consider the time it takes for a transaction to push through and carefully study movements in the markets where you plan to buy and sell crypto.
One proven way to make a profit in arbitrage trading is to place large trades. But most exchanges have withdrawal limits per day. Always keep this limit in mind before executing large trades to avoid delays and losses.
The increasing popularity of arbitrage trades can cause trading volumes to change across exchanges. High trading volumes could result in slower transactions. When trading popular currencies like Bitcoin, transactions may take longer to complete. Even a few minutes’ delay could result in heavy losses in arbitrage trading.
On the surface, arbitrage trading appears to be a simple and straightforward process with more gains than losses. But to succeed in this arena, you need to have enough trading experience and tech-savvy under your belt.
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