Cryptocurrency arbitrage attracts many experienced traders and even more beginners, since it is positioned as a risk-free and easy way to make money: no technical or fundamental analysis is needed, the initial capital can be any, and the income is almost instantaneous.
In this article, we’ll look at what cryptocurrency arbitrage actually is and why everyone knows about “spinning Binance”, but not everyone can do it in practice.
This article was produced by Incrypted and is intended for educational purposes. We hope that the material will help you better understand and study the cryptocurrency market.
What is cryptocurrency arbitrage in simple words?
Arbitrage refers to the purchase of an asset with the aim of instantly resell it at a better price on another market or in another trading pair: an arbitrageur can buy 1 ETH on the Binance exchange for $1,500, and then sell it on Coinbase for $1,600.
Both ordinary traders and large market makers make money from arbitrage, and in general this type of activity is typical for all markets. The key characteristics of arbitrage as a type of trading are:
Low transaction risk: theoretically, you can earn income without risk, since buying and selling takes place before the price has time to change significantly.
Speed: Because prices in the crypto market change so quickly, arbitrageurs must complete trades in minutes or seconds. Often this activity is automated.
Large volumes: as a rule, the income from arbitrage is small in percentage terms (rarely more than 5-10%), so in order to get tangible profits you need to carry out large transactions.
The market basis of arbitrage is price gaps (gaps), which form on different platforms or trading pairs due to different supply/demand balances. This is due to the fact that, in essence, each trading pair, and especially the exchange, is a separate market, the prices on which are formed independently of other markets. Arbitrageurs bridge these gaps by receiving income from exchange rate differences as a reward.
From a markets perspective, arbitrage is a favorable activity that minimizes price gaps and maintains a stable average asset price. Stable prices on modern CEXs would not be possible without professional large-scale arbitrageurs.
How did arbitration come about?
The history of cryptocurrency arbitrage began in the early stages of the market, characterized by low liquidity, a small number of trading platforms and fragmented capital. The difference in the BTC rate on individual sites could be several tens of percent due to the absence of large market makers and the different balance of supply and demand. Here are just a few of the most famous examples:
Huge price gap on African crypto exchanges in 2017. Thus, at the moment on the Golix site, the cost of BTC was 87% higher than the average for CEX. This is due to the financial isolation of the region and high demand caused by inflation of local fiat currencies.
A premium for BTC in the Japanese market that existed until 2018. The high cost of Bitcoin on local sites was due to the fact that most foreign sites simply could not operate within the country. It was through arbitrage that Alameda Research was able to grow BTC, which later launched FTX.
Kimchi Premium: the difference between the value of cryptocurrency on Korean and global crypto exchanges. The reason is the same as in the case of Japan - strict regulatory rules for international sites. By the way, the Kimchi award still works, although it is not as noticeable.
Before the advent of professional market makers and large institutional capital, arbitrage opportunities were available to ordinary traders. But since the 2017 bull run, more or less profitable arbitrage on the CEX has passed into the hands of market makers, who can respond to gaps faster through automation and trade more efficiently on an international scale.
Note: In the early days after the advent of DEX and DeFi, ordinary users also had the opportunity to make money on cryptocurrency arbitrage by trading between CEX and DEX or different liquidity pools/platforms. Now the lion's share of arbitrage transactions comes from bots, which can track transactions before they are processed.
Types of arbitration
There are several types of arbitration, based on the scale of the transaction and the number of links involved:
Intra-exchange: conducting transactions on the same platform, but on different trading pairs. The main advantage of this method is speed, since the crypt does not need to be transferred between sites; buying and selling can take literally seconds.
Inter-exchange: involves buying an asset on one exchange and selling it on another. This is a more complex method since it requires having accounts on both platforms and inter-exchange transfer of funds, which is associated with additional commissions and time delays.
International: An arbitrage transaction using trading platforms in multiple countries, as well as local payment methods and fiat currencies. The most difficult type of arbitration.
As a rule, along with the scale of the transaction, the number of sites/assets involved also increases, which complicates its implementation.
It is also worth highlighting DEX arbitrage, the mechanism of which is significantly different and is based on liquidity pools, slippage, the value of an asset in various networks, and even the order of transactions in the mempool. This is a big topic that we will cover in a separate article.
How is P2P arbitration carried out?
A separate type of arbitration is arbitration on P2P platforms. The main feature of P2P trading is the negotiated price between the parties to the transaction. This means that the price of a direct transaction may differ from the market price:
This is the market value of BTC on Binance when purchased through the order book:
This is the cost of selling BTC on Bitcoin P2P when paying on Payeer at the same time:
That is, you can buy BTC cheaper directly on the exchange and sell it on P2P, provided that the payment method suits you. This also works in the opposite direction: the price for P2P can be lower than the market price, although less often
Important: often it is the payment method that determines the cost when P2P buying/selling an asset: not all banks or wallets are convenient for users, others are simply not supported by the exchange. Therefore, many are willing to pay a premium for direct fiat withdrawal to the desired means of payment.
A more complex version of P2P arbitrage involves opening advertisements for buying or selling independently. In this case, the trader himself sets the offer price, which may differ from the market one in one direction or another: for example, you can buy BTC below the market price, and then sell it on the exchange or through another offer at the market price.
It is important to understand what exactly causes the price difference. Cryptan is ready to sell below the market or buy above if it receives an additional advantage, be it working without KYC, direct withdrawal of funds without commissions, or exchanging for an unpopular fiat currency. Therefore, before starting work, you need to study different P2P platforms, their prices and main advantages for users.
Arbitration links: structure and algorithm of actions
In practice, arbitrageurs work through so-called arbitrage links - algorithms that describe where and what asset to buy and where to sell in order to make money on price differences. The simplest arbitration link looks like this:
Buy ETH at price X on Binance P2P;
Withdraw it to the WhiteBit exchange wallet;
Sell on WhiteBit at price Y.
However, as a rule, the bundles are more complex and can include up to 10+ intermediate trading pairs and platforms, and also involve the use of foreign fiat currencies or a combined exchange of CEX and DEX.
Performing all the actions in a sequence is called a circle. The profitability of the link is estimated as a percentage of the invested funds that were earned at the end of the circle. For example, if a return of 15% is indicated, this means that a trader can earn 15% of his deposit in 1 round. Ideally, the connection is built in such a way that the income from the previous round can be used in the next one, gradually increasing the deposit and the amount of profit.
Important: the peculiarity of arbitrage links is their short-term nature - as soon as the link becomes public or is discovered by a large market maker, the price gap begins to shrink. As the bundle is used, due to the equalization of the supply/demand balance, the income from it also decreases.
The main task of an arbitrageur is to detect imbalances in different markets and build an arbitrage link. To do this, traders use bots, scanners, or regular data aggregators.
Scanners. What to use?
Exchange order books and blockchain transactions are publicly available, meaning price data across markets can be aggregated and analyzed to uncover arbitrage opportunities. The most accessible and simple sources of information are data aggregators:
Cryptorank offers a separate Arbitrage tab on a specific cryptocurrency page. This tab displays price gaps when trading on various platforms. Now this is the most convenient free tool for tracking bundles:
A complete list of markets for each currency is available on Coinmarketcap, which allows you to monitor rate differences in different trading pairs and on different crypto exchanges:
Dexscreener allows you to track the liquidity pools for a selected pair or coin, and therefore the exchange rate differences in these pools. But it is important to consider that the pools themselves can be deployed on different DEXs and even on different networks:
Monitoring price gaps and building links manually requires a lot of effort and time - that is, the resource that arbitrageurs have the least amount of. Therefore, many traders use scanners that allow them to automatically or semi-automatically detect bundles and trade on them. Examples of such services:
Coingapp;
Arbitragescanner;
ArbiTool.
Such software can be paid or free, which directly determines its functionality. Thus, free versions mainly provide only exchange directions and can send notifications to social networks, while more complex software uses trade bots and API trading to immediately use the discovered pair.
Important: there are dozens and hundreds of similar scanners on the web from different developers. Some require connecting exchange accounts or making a deposit for automatic trades. That is, real money is at stake, which you transfer to the control of the software, which means that before installing and using the scanner, be sure to DYOR!
Additional sources
In addition to open data aggregators and specialized software, arbitrageurs, especially beginners, use other sources of information to search for connections:
TG channels with various connections, schemes and signals: as a rule, such channels offer information late or try to sell their product to the audience.
Alpha clubs and private groups: for this area of activity there are also closed chats, groups and servers. Sometimes, they can offer more up-to-date information than public sources.
Other Social Media: Niche influencers on Twitter often post arbitrage and tie-up related information.
The reliability and relevance of such data depends on the source. As a rule, you have to pay for early access to really working connections and, of course, no one can predict how long the direction will be profitable. Therefore, it is important to learn how to build connections yourself and analyze the market in search of opportunities.
An alternative to signals and connections are also arbitration courses from influencers and traders. They often include information from open sources, but the effectiveness of the course should be assessed separately in each case, and for this you should first familiarize yourself with open information in order to better navigate the niche and understand how useful the content of a paid training product will be.
Is arbitration legal?
Arbitrage is a legal trading activity as long as the regulatory requirements of the platforms used are met. These rules may include:
passing KYC;
trading limits;
verification of means of payment.
The main charge that an arbitrageur may face is money laundering. To avoid it, it is enough to prove the origin of the deposited assets. It is also not recommended to use mixers or other anonymization tools, as such transactions are flagged by exchanges as high-risk and may be frozen.
When using automation tools that provide a direct connection to an exchange account (automated API trading), it is worth studying the site’s policy in relation to such software.
Important: the issue of legality of transactions becomes more complex as the number of jurisdictions and channels of interaction with fiat increases. For example, not in all countries banks support transfers to crypto exchange accounts or withdrawal of funds, and some local sites may be closed to foreigners.
Which exchanges should I register for arbitrage?
The specific list of platforms depends on the scale of your transactions and the type of platforms for interaction (CEX or DEX). As a rule, the largest price gap occurs between pairs on top exchanges and little-known sites, so you may need accounts on:
Binance.
Kraken.
Bittrex.
Bitstamp.
To get a complete list of exchanges, you first need to research possible arbitrage directions for the selected assets. For example, you can use the Arbitration section on Cryptorank as a starting point. Here you can immediately see the exchanges between which arbitrage is possible:
In addition, arbitrage automation software only supports certain CEX and DEX. If you plan to use this tool, you will receive a list of sites for registration after downloading and launching the application. That is, you should proceed to creating accounts only after monitoring the market, searching for common combinations and studying the platforms involved.
The general rule for a professional arbitrageur is that the more accounts, the more potential connections.
But it’s not always easy to register on an exchange and go through KYC, especially when it comes to closed local platforms or little-known exchanges. It is important to maintain a balance between the number of accounts, the complexity of their registration and the efficiency of use.
Conclusion
Cryptocurrency arbitrage is making money on the difference in the prices of an asset in different markets. It provides quick and relatively low-risk income on inter-exchange trading. In general, this is a positive development for the crypto market, since it allows us to reduce the fragmentation of capital and ensure a stable average cost of cryptocurrencies.
In the early stages of the market, arbitrage was available to ordinary users and provided opportunities for making money even with small capital. Now this niche is occupied mainly by professional market makers and trading bots, who close price gaps faster and more efficiently than most traders.
However, the opportunity to earn income remains today. To do this, an arbitrageur must have developed skills in searching and analyzing information, as well as manage dozens of accounts and wallets on centralized and decentralized sites. So DYOR and successful connections!