Crypto Arbitrage: Overview, Trading Strategies, Opportunities, and More

Cryptocurrency arbitrage is an interesting concept with favourable outcomes but there is more that a trader must know about arbitrage opportunities in the crypto market. Find it all out in this blog.

We cover:

  • What is Arbitrage?
  • How are cryptocurrencies traded?
  • What is cryptocurrency arbitrage?
  • Why do cryptocurrency arbitrage opportunities occur in the market?
  • How to identify cryptocurrency arbitrage opportunities
  • Types of arbitrage opportunities in the cryptocurrency market
  • How to begin cryptocurrency arbitrage trading?
  • Advantages of cryptocurrency arbitrage
  • Drawbacks of cryptocurrency arbitrage

What is arbitrage?

Arbitrage means capturing the profit opportunities stemming from the price differences between different markets for an asset.

Assume an asset X is traded in two markets, market A and market B. If it is traded at 100 in marketplace A and 105 in marketplace B, one can enjoy a riskless 5% profit opportunity excluding transaction cost.

Before diving into cryptocurrency arbitrage, let’s first understand how cryptocurrencies are traded.

How are cryptocurrencies traded?

Cryptocurrencies are mostly traded in centralized exchanges. Users can bid or ask for the cryptocurrency that they want to trade and once a particular buy and sell order matches, the exchange of the assets are realised between buyer and seller.

Based on this logic, cryptocurrencies are traded 24/7 around the world. The same cryptocurrencies are traded on thousands of different exchanges.

For example, you can see some of the markets in which BTC is traded below:

Source: Coinmarketcap

What is cryptocurrency arbitrage?

Cryptocurrency arbitrage is profiting from simultaneously buying a cryptocurrency from an exchange and selling it on a different one with a slightly higher price.

If you check the price column in the above Bitcoin Markets list, there are slight differences between the prices on different exchanges. Although these slight differences cannot absorb the transaction costs, you can experience net arbitrage opportunities during highly volatile times.

Why do cryptocurrency arbitrage opportunities occur in the market?

As mentioned, cryptocurrencies are traded across thousands of exchanges in the world. They are traded in different fiat currencies and they are also traded in major cryptocurrencies.

There are several reasons causing arbitrage opportunities between different markets.

Local Restrictions Imposed to Fiat Currency Transfers

Some countries restrict the flow of capital out of the country, leading to local cryptocurrency investors being barred from accessing the cryptocurrency markets outside the country. That causes imbalances between supply and demand in the local cryptocurrency exchanges.

The most famous example of this situation is Kimchi Premium. In South Korea, there is tight capital control for cryptocurrency investors and foreign cryptocurrency investors are not allowed to trade in local cryptocurrency exchanges. Therefore, cryptocurrency prices in the country deviate from other cryptocurrency markets.

The below chart shows this deviation. As you can see, most of the time, the price of Bitcoin is more expensive in South Korea compared to other markets and this situation is called ‘Kimchi Premium’ among cryptocurrency investors.

Source: CryptoQuant. Green-Red Line: Korea Premium Index, Black Line: BTC Price in USD

Sudden Changes in the Prices

Cryptocurrencies are prone to high price movements as history has shown. The prices can go down 20% and up 20% within the same day. Sometimes it may be impossible for traders placing orders manually to cancel their orders.

Also, some crypto exchanges may show slightly slower or quicker reactions to these price movements because of the liquidity differences between cryptocurrency exchanges.

For example, when cryptocurrency prices start to decrease, market orders in an illiquid exchange would cause prices to drop more severely, which may give rise to arbitrage opportunities.

Transaction and Transfer Costs

Sometimes although there are no restrictions and no high volatility environment, the difference between prices can be seen because of the transaction costs.

You may think that although there are differences between the prices it may not mean that there is an arbitrage opportunity. However, not everyone in a cryptocurrency exchange has the same transaction cost.

Transaction costs in cryptocurrency exchanges are typically much lower for the investors producing high trade volumes. Therefore, these price differences would be slight arbitrage opportunities for them.

Visit QuantInsti to read about the types of arbitrage opportunities in the cryptocurrency market and to see the rest of the article:

Disclosure: Interactive Brokers

Information posted on IBKR Traders’ Insight that is provided by third-parties and not by Interactive Brokers does NOT constitute a recommendation by Interactive Brokers that you should contract for the services of that third party. Third-party participants who contribute to IBKR Traders’ Insight are independent of Interactive Brokers and Interactive Brokers does not make any representations or warranties concerning the services offered, their past or future performance, or the accuracy of the information provided by the third party. Past performance is no guarantee of future results.

This material is from QuantInsti and is being posted with permission from QuantInsti. The views expressed in this material are solely those of the author and/or QuantInsti and IBKR is not endorsing or recommending any investment or trading discussed in the material. This material is not and should not be construed as an offer to sell or the solicitation of an offer to buy any security. To the extent that this material discusses general market activity, industry or sector trends or other broad based economic or political conditions, it should not be construed as research or investment advice. To the extent that it includes references to specific securities, commodities, currencies, or other instruments, those references do not constitute a recommendation to buy, sell or hold such security. This material does not and is not intended to take into account the particular financial conditions, investment objectives or requirements of individual customers. Before acting on this material, you should consider whether it is suitable for your particular circumstances and, as necessary, seek professional advice.

In accordance with EU regulation: The statements in this document shall not be considered as an objective or independent explanation of the matters. Please note that this document (a) has not been prepared in accordance with legal requirements designed to promote the independence of investment research, and (b) is not subject to any prohibition on dealing ahead of the dissemination or publication of investment research.

Any trading symbols displayed are for illustrative purposes only and are not intended to portray recommendations.

Disclosure: Forex

There is a substantial risk of loss in foreign exchange trading. The settlement date of foreign exchange trades can vary due to time zone differences and bank holidays. When trading across foreign exchange markets, this may necessitate borrowing funds to settle foreign exchange trades. The interest rate on borrowed funds must be considered when computing the cost of trades across multiple markets.

Disclosure: Digital Assets

Trading in digital assets, including cryptocurrencies, is especially risky and is only for individuals with a high risk tolerance and the financial ability to sustain losses. Eligibility to trade in digital asset products may vary based on jurisdiction.