It’s no secret that cryptocurrency trading has seen an explosion over the course of the last year-plus. Many factors have conspired to create this trend, but the overarching reason crypto trading has become so popular is that people are making money. Lots of it.
What separates the traders who have life-changing success from those who just get by or even fail at crypto trading? Again, there are a lot of reasons, but much of it comes down to having the right trading strategy.
Crypto trading strategies multiply by the day. Some are easier to execute and others are more difficult. Some are riskier than others and some take more technical know-how. Generally, the best and most popular strategies fall somewhere in the middle of all these poles.
One especially popular trading strategy these days is cryptocurrency arbitrage. Here, we will explain what this strategy is, how it works, why it is popular, and examine if there are any downsides to this strategy. This is not meant to be investment advice nor are we investment advisors. We’re merely explaining this common trading strategy. Here is why cryptocurrency arbitrage is a particularly popular trading strategy.
What is Cryptocurrency Arbitrage?
Cryptocurrency arbitrage is a trading strategy that exploits the inefficiency of the crypto market. This may sound like a shady business practice, but arbitrage is a completely normal (and legal) way that traders have been making profits in markets for years.
Cryptocurrency exchanges number in the hundreds right now--around 500, in fact. And the crypto market moves so fast that the price of cryptocurrencies doesn’t change at the exact same time on each exchange. Cryptocurrency arbitrage is when you buy crypto at one price on one exchange and quickly sell it at a higher price on another exchange, all to net a tidy profit.
How Does Cryptocurrency Arbitrage Work?
Cryptocurrency arbitrage involves keeping an eye on multiple cryptocurrency exchanges. This could mean the big, well-known ones such as Coinbase or Kraken or any of the smaller ones you like. With this strategy, it is usually good to have a mix because market makers on smaller exchanges usually look to the bigger ones before they move. This can create a nice arbitrage opportunity.
When you are observing these exchanges, you’ll need to keep an eye on the order book for the cryptocurrencies you are looking to trade. These are charts that show the ask and buy prices for a particular asset. This is often displayed in the form of a candlestick chart. Once you see that the spread (difference between ask and bid) on a particular exchange is lower than another, you can buy that cryptocurrency (as much as the trading volume and your budget will allow) and sell it quickly on the other exchange.
These differences between exchange pricing are generally small, so cryptocurrency arbitrage generally needs to be a high-volume play in order to be very profitable. This is a simple definition of arbitrage, but if it sounds like a strategy you would like to learn more about, there are some good resources to do so. This guide from Cove Markets goes into greater detail on the ins and outs of cryptocurrency arbitrage strategies.
Why Is Cryptocurrency Arbitrage Particularly Popular?
Why do so many successful traders like to use arbitrage as their trading strategy? There are several answers to this question. First, it’s a very fast way to make a profit.
The crypto market is very volatile, so arbitrage must usually be done in a matter of seconds to be successful. If you do this quickly enough and at a large enough volume, you can have a big windfall less than a minute after identifying the opportunity. There aren’t many other types of trades where that is true.
Another reason arbitrage is so popular is that the crypto market is growing so fast. In 2018, there were perhaps 200 crypto exchanges worldwide. Just three years later, there are now about 500 different exchanges. Given the crypto market’s trajectory, that number is expected to swiftly grow in the coming years. More exchanges mean more opportunity for arbitrage, as all the exchanges move at different paces.
One last reason that well-schooled traders like arbitrage is that it is actually good for the market. Vastly inefficient markets aren’t good for almost anyone in the long term, and arbitrage helps make the marketplace a more efficient one. When traders exploit the price difference on different exchanges, it actually serves to bring the prices on different exchanges closer together, resulting in a more efficient market.
Is There Any Downside to Cryptocurrency Arbitrage?
If this is a strategy you think you want to pursue, be warned; this is not a fool-proof strategy that works every time for every trader. Even the most experienced trader can get burned from time to time using a cryptocurrency arbitrage strategy because of the inherent risk involved.
When you implement this strategy, you risk the markets adjusting before you execute your trades. This is especially pertinent in the crypto market because it is volatile and moves fast. If your buy price jumps up unexpectedly or your sell price slips prior to making your trade, you risk losing your profit or even losing money in some cases.
Also, you have to be very careful that you understand the trade volume on the sell side of your equation. If you are buying from a big exchange and selling to a small one, there is a chance you will find you don’t have enough buyers who want to buy in quickly enough to complete your arbitrage trade.
Cryptocurrency arbitrage has long been a popular and successful strategy. In the crypto market, as long as it stays volatile and there are a lot of exchanges to trade on, it will likely stay profitable for a long time. As long as you know the risk and execute it right, arbitrage may be profitable for you too.