Arbitrage has to be one of the oldest, yet an effective trick to make easy money. To justify the tag of the oldest yet effective trick, say a merchant travels from Constantinople to Peking and finds that the price of gold is cheaper in Peking when compared to Constantinople. The merchant then decides to buy gold in Peking and sell it in Constantinople at its market price, thus making a profit above the market price of Constantinople, which is nothing but arbitrage.
Arbitrage takes advantage of the market inefficiencies to make profits. It is much more prevalent in the crypto market which has led to huge profits and margins as high as 10%. There are two types of arbitrage which are prominent in crypto-trading, inter-exchange arbitrage and intra-exchange arbitrage. Let us understand them:
Cryptocurrencies and tokens are traded mainly on exchanges. Currently, there are more than 200 exchanges on which one can buy crypto. These 200 exchanges open up the possibility for traders to buy a crypto on one exchange, move it to another exchange which values the same crypto higher than the previous exchange and sell it there. The logical question from here would be, why will the asset be valued differently in different exchanges?
The price of an asset is determined by the strength of the project underlining that crypto or the volume for that asset in a particular exchange, among other parameters. New information regarding a crypto also trigger a change in its price. These changes are reflected in any one of the 200 plus different exchanges at 200 plus different rates. This lag shown by exchanges to react to market triggers can be exploited by traders. One can develop a trading bot to automate the profit taking or just manually keep track of few assets.
An example for inter-exchange arbitrage is buying bitcoin for $6318.00 from Binance and selling it for $6363.71 on Bittrex (prices as of July 11th, 12:30PM). This trade leads to a profit of 0.72%, which roughly beats the transaction fees and transfer fee.
Another example, which truly shows the power of arbitrage is buying AppCoin on Binance for 0.00003238 BTC and selling it on hitBTC for 0.00003999 BTC (prices as of July 11th, 04:40PM). This converts to a profit of a whopping 23.51%.
A rule of thumb is to look for an arbitrage which leads to 0.75% profit or more. This golden percentage covers the transaction costs and transfer fees, which vary from one exchange to another.
Intra-exchange arbitrage focuses on one particular exchange and negates the cost incurred in transferring the crypto from one exchange to another. Inter-exchange arbitrage is done by triangular arbitrage. In a triangular arbitrage, three cryptos are chosen and a triangular buy and sell order are pushed to leverage the variability in the value of a crypto with respect to other cryptos or fiat currencies. A real-world example of triangular arbitrage is the following set of trades done on July 11th, 05:00 PM in Bitfinex, a crypto trading exchange:
1.Buy 10 Maker (MKR) with USD. It will cost $5510.7.
2.Use this MKR to buy BTC. 10 MKR will get you 0.87806 BTC.
3.Convert this BTC into USD. 0.87806 BTC will yield $5586.66.
This lead to a profit of 1.38%. Thus, Intra-exchange arbitrage can also lead to decent profits, with the profits staying well above the rule of thumb. One constraint is that these trades need to go through in a few seconds to capture the exact prices and ensure maximum profits possible from that triangle.
Crypto-arbitrage is an enticing strategy for traders who can code and build a bot, but there are certain constraints and pointers to keep in mind before jumping into it.
1.The exchange being targeted for arbitrage must have enough volumes to push through a buy or sell order at the desired price.
2.If the Bid/Ask spread is too high, there can be a lot of variability introduced which can impact the signals for predictability of arbitrage.
3.If the volume is low, then the order book is thin, leading to the availability of interest at different prices very thin.
4.Shorter trading cycles (~2-3 seconds) have the potential to make higher arbitrage profits. But, the time taken by exchanges to process an order of BTC can take anything between 10 minutes to 8 hours.
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