Anyone that took even a small look into the crypto industry can note the obvious price difference between exchanges. How does this work? How can one currency have multiple prices on different platforms? Interestingly, price variations can be noted on all cryptocurrencies. Even the most liquid currencies seem to have different prices across separate platforms.
What is Crypto Arbitrage
Cryptocurrency prices are calculated by every trading platform. The calculation might vary from platform to platform. Most, just calculate the price by finding the average selling/buying price on that exchange.
After seeing the price difference across platforms, many people wondered how to benefit from it. If you have though of this, then you are not alone. This is a technique employed by many and it is called crypto Arbitrage.
Crypto Arbitrage is the trading technique that allows a user to exploit the price difference across exchanges. This technique is employed in order to profit from it. While bitcoin can be $10,000 on one exchange it can be $10,100 on another. This will result in $100 profit for every bitcoin bought on one of the exchanges and sold on the other.
Despite its potential return on investment, cryptocurrency arbitrage can be a risky technique. This comes due to the risky volatile nature of crypto. Traders have to make quick decisions to take advantage of small opportunities. This opportunities can be significantly larger when trading more coins but so is the risk.
Despite its risks, experienced traders seem to profit from this technique consistently. The combination of speed and proper timing is imperative. Such successful traders are often referred to as arbitrageurs.
An Introduction to Crypto Pricing
Many of you may be wondering how cryptocurrency exchanges profit off user trades. A number of people argue that such trading platforms depend on speculative value. They argue that the price is determined by non-tangible market aspects.
On the other hand, some experts argue the complete opposite. They say that the value of cryptocurrency is backed by the willingness of the user to transact. It is obvious that both thought are not appropriate in the context of supply and demand.
At the smallest level, crypto exchanges calculate the prices based on simple criteria. The buy and sell orders of their customer. In a typical trade, a customer would make an order to purchase one bitcoin for $10,000. If a different trader is willing to sell his coin for the same price, an exchange takes place. After recording the sell order the trade is completed. Exchanges then calculate the average price of such buy and sell executions. This then translate to the average selling price of bitcoin on that platform.
Arbitrage Techniques and Limitations
On a basic level, crypto arbitrage is used to describe something basic. The two main methods that are used by a trader to buy and sell cryptocurrency assets.
Traditional arbitrage occurs when an "arbitrageur" trades one specific cryptocurrency across multiple platforms. The slightly more advanced method is called triangular arbitrage. This refers to the practice of exploiting price differences between three digital assets. Triangular arbitrage usually takes place on the same trading platform.
Here is an example of triangular arbitrage. A crypto trader might purchase Bitcoin using U.S. Dollar. Then the arbitrageur would exchange the bitcoin for Ethereum. The final conversion is back to U.S. Dollars. If calculated correctly, the technique should yield some profit.
Arbitrage is not a new technique. It has been employed by experienced traders long before cryptocurrency. This technique is not very complicated and can result in significant profits over time. Despite that, there are a few issues that should be noted. Even as a price windows might occur, you have to act very quickly. The coins have to be transferred from one exchange to the other before the price window closes. In addition, regular arbitrageurs may find it expensive to transfer the coins from to another exchange. Triangular arbitrage is not affected by this. This makes it easier to execute as long as the calculations are correct.