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: https://blog.quantinsti.com/crypto-arbitrage/.

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Disclosure: Forex

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Disclosure: Digital Assets

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