Bitcoin Arbitrage: A Beginner’s Guide

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Coinmonks

6 min readJun 30, 2021

You’ve probably heard of Bitcoin arbitrage if you’re familiar with cryptocurrency trading and bitcoin trading. Generally speaking, arbitrage is the process of buying and selling an item at the same time on separate platforms, exchanges, or locations in order to profit from the price difference. The same can be applied to the cryptocurrency market, with only a few differences compared to arbitrage in traditional markets.

To put it another way, crypto arbitrage, or Bitcoin arbitrage, is a process in which traders trade cryptocurrencies based on price disparities between exchanges. They may purchase the cryptocurrency at a lower price on one exchange and sell it at a greater price on another, profiting in the process. Let’s illustrate this through an example.

Let’s imagine the price of one Bitcoin is $8,000 on Exchange 1. Let the price on exchange 2 be $8,500. As a result, the price difference would be $500. Assume that a person purchases 50 bitcoins from Exchange 1 for $8,000 each and then sells them for $8,500 each on Exchange 2. Here’s how it would work out if you did the math:

Exchange 1 price of 50 bitcoins = 50*$8,000 = $4,00,000
Exchange 2 price of 50 bitcoins = 50*$8,500 = $4,25,000

As a result, total profit is $4,25,000 minus $4,00,000 = $25,000

This may appear to be a simple process. The only sticking point appears to be having sufficient funds to purchase a large amount of Bitcoin from Exchange 1 in the first place. On the surface, there appear to be no risks and only gains to be made by leveraging price differences on various exchanges.

However, if you dig underneath the surface, you’ll discover that achieving a successful arbitrage involves a number of risks, especially given how unpredictable crypto markets are.

If you’re just getting started on Bitcoin or crypto arbitrage, here are some things you need to know. First, let’s start with the basics and get into some of the most common methods of arbitrage that are currently seen.

Arbitrage Methods

1. Spatial arbitrage

This is the simplest and most fundamental form of arbitrage, in which traders buy and sell cryptocurrencies on two exchanges at the same time in order to profit from market inefficiencies. A trader will acquire crypto from the platform with the lower price and then sell it at a greater price on the second exchange immediately.

2. Triangular arbitrage

Traders use triangle arbitrage to benefit from three cryptocurrencies by leveraging price differences. A trader might, for example, exchange Bitcoin for Ether, then convert Ether to Litecoin, and then trade Litecoin back to Bitcoin. If the values of Litecoin and Ether are favorable to you, you will be able to earn more Bitcoin.

3. Statistical arbitrage

Traders who employ this method profit from arbitrage opportunities at scale by using quantitative data models, bots, and complex trading algorithms. Essentially, this method includes estimating the minute price difference after all fees from all exchanges has been taken into account.

4. Flash-loan arbitrage

Flash-loans and flash-loan arbitrages are all the hype these days and are considered one of the most significant developments in Decentralized Finance (DeFi). Unlike traditional banking systems, where requesting loans and receiving approval takes a long time, flash loans allow customers to borrow any amount they want without putting up any collateral or passing a credit check.

As a result, flash loans enable traders to borrow money more quickly, leverage multiple decentralized exchanges, and instantly switch currencies in and out of one transaction. Substantial earnings can be made by trading in a few different cryptocurrencies rather than just one or two.

Risks of Bitcoin arbitrage

Although the possibilities and potential for enormous earnings in crypto arbitrage are incredibly high, expertise is essential, as is having a few trader’s tricks and techniques up your sleeve. Beginners and new investors are frequently duped by the popular portrayal of crypto arbitrage, in which traders are depicted buying crypto from one exchange and then selling it for profit on another with little risk.

Here are the major risks you need to consider before getting involved in Bitcoin arbitrage.

Hefty trading and withdrawal fees

Most exchanges charge exorbitant fees on both trading and withdrawal. As a result, even if you were to make profits off your arbitrage, a significant amount of this would be taken by exchanges. However, this risk can be easily mitigated if traders research well and get a deeper understanding of fee structures on various exchanges.

Market volatility

The crypto market being highly volatile, market volatility is a major risk in crypto arbitrage. You might have bought the cryptocurrency at a lower price from one exchange, but by the time you’ve sent your funds to the other exchange, the price levels might have gone down, and this could result in major losses for traders.

Timing

Just like market volatility, timing is also crucial in crypto arbitrage because price fluctuations happen in the blink of an eye. If you don’t immediately sell off the Bitcoin you bought at a cheaper rate from the other exchange, or if your transaction has a long waiting time to be processed, you may end up making more losses than gains. Hence, research transaction and processing times on various exchanges before finalizing your arbitrage.

Same names

Several traders have fallen prey to the same name issue. With over a thousand cryptocurrencies on the market, the possibilities of some of these projects sharing the same name or symbol are extremely high. As a result, if you get confused and send the wrong coins to the wrong wallet address, you will lose all of your funds. Here are a few examples of cryptocurrencies with similar names :

Cashcoin CASH and Cash Poker Pro CASH
Bitcoin Scrypt BTCS and Bitcoin Silver BTCS
ArcticCoin ARC and Arcade Token ARC
LiteBitcoin LBTC and Lightning Bit LBTC

Comparing your selected cryptocurrency prices and volumes across multiple exchange platforms is the easiest method to deal with this. If the price difference is ridiculously large, it’s most likely not genuine. You can further verify the coins by checking for logos on different exchanges and see if they match.

Wallet status

Wallets on exchanges are frequently disabled, inactive, unavailable, undergoing repair and maintenance, or running on different Blockchains between two exchanges. You won’t be able to transfer funds if your wallet isn’t online, and you’ll end up losing a lot of money. As a result, the best thing to do is make sure your wallets are online on all of the platforms where you trade. You can also check if the wallets are on the same blockchain to double-check the transaction’s validity.

Conclusion

Crypto arbitrage is a great way to make some profits, provided you consider the risks and do it the right way. It is now gaining traction among hedge funds, financial institutions, and investment organizations, in addition to ordinary investors.

The entire process involves minimal effort and gives higher returns, thereby attracting a number of people. Although there are risks involved, they can be smartly mitigated if traders use the right strategies. And with the availability of flash loans now, the entire process has been made a whole lot easier.

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