The Capital
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The Capital

Arbitrage trading in crypto

By Andrey Costello on The Capital

The age-old strategy of arbitrage capitalizes on price imbalances between markets — but how does it work in the cryptocurrency world?

It may have crossed your mind that these differences bring about excellent arbitrage opportunities. However, it might not be as straightforward as it looks at first glance.

Arbitrage of bitcoins and cryptocurrencies is becoming a popular strategy. The presence of a large number of exchanges, their decentralization, allow to invent various schemes of speculation and fast earning. Let’s look at some examples of cryptocurrency arbitrage.

For many traders, arbitrage trading at Forex market has long been not a secret, but a source of stable profit. Meanwhile, this strategy can be successfully applied in the cryptocurrency market as well.

What is arbitrage in general?

This type of trading benefits from the imbalance of prices in different markets. That is, the price differences for the same coin. Simply put, it is when an asset is almost immediately bought and sold in two different exchanges, where prices are slightly different.

For example, shares of some technology company can be sold at $35 on the New York Stock Exchange and at $35.10 in London. Of course, the difference is small, but fast wholesale purchase of shares at a lower price and sale at a higher one can bring a discerning trader a decent profit. This concept reflects the whole essence of arbitrage, and in comparison with other strategies the risk is relatively low.

You may wonder: how can such discrepancies occur? There are many reasons. Currency fluctuations may mean that shares will be undervalued on foreign exchanges. Markets are imperfect, and it is difficult to achieve synchronization of all exchanges. Asymmetric information from buyers and sellers also favors arbitrage.

It should be noted that at low profit, trading commissions can make many arbitrage opportunities financially meaningless. Arbitrage is possible in various financial instruments other than shares, which brings us to the following question.

Can you make money out of crypto arbitrage?

Yes, the concept is the same, but the asset is different. There are a lot of exchanges in the world now, offering customers the opportunity to buy cryptocurrency. But the prices offered for digital currencies like Bitcoin BTC or ETH may differ significantly.

Such differences usually occur where the cryptocurrency is in high demand. One of the most frequently cited examples is the “kimchi premium”. The term first came into use in late 2017, when the maximum BTC price in South Korea was 30 percent higher than the market average. While the BTC rate reached 19.5 thousand dollars at the peak all over the world, in Korea the largest cryptocurrency traded at 25 thousand dollars.

Zimbabwe is an African country suffering from hyperinflation, so vital goods such as food and fuel can become much more expensive in a matter of days or even hours. There were times when locals had to go to grocery stores full of Zimbabwean dollars just in case. In 2017, the price of Bitcoin on a local exchange was almost twice as high as on international platforms, partly because local consumers could not access foreign exchanges. That’s when the oppression of Bitcoin began in this country.

Bitcoin also traded margins in Hong Kong against the backdrop of political protests there. Last August, local traders paid 2 percent more for the coin than in other countries. That same month, the markup of 4 percent was in Argentina, when the peso collapsed after unexpected election results.

Even if economic and political conditions are excluded from the equation, price differences between exchanges can favour arbitrage.

Is it popular in crypto industry?

Arbitrage has been around for centuries and is beginning to gain popularity in the crypto world — but the possibilities can be short-lived.

Changes in supply and demand when moving the cryptocurrency from one exchange to another can affect prices. Market volatility can mean that arbitrage opportunity will quickly disappear — but at the same time, unpredictable price changes often create new opportunities. With the right approach, it is theoretically possible to earn a decent sum in a short time — and since there are more than two hundred exchanges, exchange divergence is inevitable.

There are also new approaches to cryptocurrency arbitrage, which do not use exchanges. Paxful — peer-to-peer Bitcoin exchanger, which directly connects buyers and sellers and allows you to buy BTC using more than three hundred payment methods. Thanks to it, users from the U.S. and Europe can sell BTC to those in markets where it is harder to buy or more expensive — and the buyer will save compared to the price on the local exchange.

There is also possibility of arbitrage of payment methods. While it may be cheaper to buy BTC by bank transfer, a surcharge is often applied when using gift cards. The platform representatives claim that this gives the crypto community the opportunity to take advantage of this difference.

Does cryptocurrency arbitrage have risks?

Legal and financial barriers can make it difficult to profit from crypto arbitrage.

Regardless of the type of cryptocurrency arbitrage, the platforms charge transaction fees — and sometimes also withdrawal fees. Therefore, it is important for a trader to consider these costs in order to make sure that some profit remains in the end.

International arbitration can also complicate client identification laws (KYC). These are strict requirements, under which sometimes a trader can only conduct transactions on the exchange once a valid passport or other document issued by the government has been provided. All of this is necessary to prove your identity.

Another problem of exchangers may be related to delays in withdrawals. If your time is limited for not moving funds from one platform to another, slow transfers may mean that you will miss your chance to earn money before completing the transaction.

You should also be careful with exchangers that offer prices for Bitcoin and other cryptocurrencies well below market rates. While this may look like an irresistible chance of making a good profit, you should first thoroughly examine and check if the exchange is reliable — otherwise you may lose your capital. The reason may be a hacking due to poor security, or banal inability to withdraw funds.

There is no unambiguous answer to the question whether arbitrage trading in cryptocurrencies is worth the effort. As a rule, people with good experience of trading on markets and those who know how to distinguish between favorable opportunities are successful in this sector. And while it is possible to benefit from a difference of 20 percent between the buy and sell price, it is prudent to ask yourself whether it is worthwhile to conduct a transaction if the spread does not exceed, for example, 5 percent.

Before embarking on arbitration, it is important to keep in mind the legal, technical and financial obstacles, as well as possible fees and volatility in the crypto market. However, having platforms that know no boundaries and connect buyers and sellers directly can inspire renewed interest in arbitration.

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Andrey Costello

Andrey Costello

Bitcoin-maximalist. Optimistic family man and miner with six years of age. I write about complicated things from the future for people of our days.