Arbitrage is a term used to describes a method of trading that takes advantage of imbalances in prices between markets. Crypto arbitrage usually takes advantage of pricing differences in digital assets on exchanges.

Crypto arbitrage takes advantage of the fact that cryptocurrencies can have significant price differences depending on the exchange sells them. In simple terms, crypto arbitrage occurs when an asset is simultaneously bought and sold in two market—the same asset bought on one exchange and sold on another to profit on the price variance.

Crypto Arbitrage: An Overview

Cryptocurrency trading is huge, with billions of dollars worth of crypto being transacted in millions of trades. There are dozens of exchanges now operating globally that provide crypto services. However, there can be significant differences comparatively on exchanges for the prices of digital currencies listed—making the crypto industry ripe for arbitrage.

Arbitrage traders take advantage of the price differences on exchanges and play these variances off each other to make a profit. For example, an exchange like Binance may list Bitcoin (BTC) for $15,200 while Kraken lists the BTC for $15,000 at the same time. An arbitrageur will buy the lower Kraken price and sell on Binance to make a quick profit of $200. This is called spatial arbitrages.

Sounds easy, but of course there is more to it than that otherwise, we would all be rich. In crypto arbitrage, it is all about speed. The example above is quite exaggerated and such a clear gap in price is unusual, however, given the extent of decentralization in the crypto sector, such discrepancies can happen very frequently.

The smaller price gaps between that do exist do not last very long. Arbitrageurs need to be quick to take advantage of these gaps which creates the risk, but if timed correctly, the profits can be huge.

Example of Price Variance Across Exchanges (Source: Coinranking.com)

A recent example where crypto arbitrage was rampant occurred when Filecoin was first launched on exchanges in October 2020. The discrepancy in price on exchanges was massive—the price of a single Filecoin (Fil) was $68 according to CoinMarketCap at the time, but CoinGecko has priced Fil at $29, meanwhile Uniswap was trading it at $25.56 and Gemini priced Fil at $29.

Methods of Crypto Arbitrage

There are three main methods of crypto arbitrage—the first is called spatial arbitrage, which is the most common and takes advantage of the price imbalances of exchanges and we have discussed this in the previous section.

The other two methods are cross-border arbitrage and statistical arbitrage.

Cross-border arbitrage is like spatial arbitrage with the key difference being that the two exchanges being played off one another are in different countries. Arbitrageurs often have difficulty in executing cross-border arbitrage as the countries that put a higher premium on some assets are usually able to do so as the users cannot access outside markets, which means it may be difficult to move assets between these markets.

Statistical arbitrage is the most sophisticated method but also carries the most risk and is heavily reliant on speed based on mathematical modeling. These techniques employed by crypto arbitrageurs involves using trading algorithms that capitalize on pricing discrepancies that may only exist for the briefest moment.

Is Crypto Arbitrage Legal and Worthwhile?

Crypto arbitrage opportunities arise from mispricing between exchanges, but the practice is completely legal. So why doesn’t everyone do it?

There are many factors to consider for crypto arbitrage, for instance, exchange platforms used will normally charge fees for transactions and often withdrawal fees. As the gaps necessary for profit are so small, failing to factor in these fees by traders could see a loss of profit.

Time is of the essence and another concern with exchanges can be delays that can be associated with executing withdrawals. Crypto arbitrageurs have a limited time frame to get funds from one platform to another, a delayed transfer could cos the trader all expected profits.

Other factors that need to be considered are regulatory—particularly for cross-border arbitrage as there are different KYC and AML compliances for different jurisdictions.

Crypto arbitrage is not for new and inexperienced traders and those who have plenty of experience in the marketplace is known to have higher levels of success. New traders may see the possibility of capitalizing on a price inconsistency but often fail to consider the myriad of factors above—fees, regulation, and timing.