What is cryptocurrency arbitrage? All about trading strategy

Introduction

Cryptocurrency arbitrage is a trading strategy that exploits the price differences between two or more exchanges. It is a popular strategy among cryptocurrency traders because it offers the potential for relatively low-risk profits. Through cryptocurrency arbitrage, traders can take advantage of discrepancies in the pricing of cryptocurrencies across different exchanges to make profits. It involves buying a cryptocurrency on one exchange at a lower price and then selling it on another exchange at a higher price. This allows traders to make profits without taking any risks associated with holding the cryptocurrency for a long period of time.

BaseTrading and investment

Types of Arbitrage Operations

Arbitrage transactions include many different methods and options. Let’s consider the main ones.

Exchange arbitration

The easiest way, involving the fastest possible purchase and sale of the same asset on various exchanges or platforms. In the event of a price discrepancy for an asset, a trader purchases a cryptocurrency on one platform at a conditional price of $100 and sells it for $101 on another. The $1 difference is the very arbitrage opportunity and market inefficiency used by traders.

Triangular Arbitrage

This type of operation involves the use of several trading pairs on one or more platforms. This strategy assumes that the trader has found a pricing inefficiency in a chain of speculative transactions.

Let’s say BTC/USD = $20,000, BTC/ETH = 0.05 BTC, ETH/USD = $1010. In this case, the trader buys 1 BTC for $20,000, then exchanges 1 BTC for 20 ETH and completes the chain of operations by exchanging 20 ETH for $20,200. The profit per operation is $200.

Arbitrage using derivatives

The most complex and, accordingly, risky type of arbitrage operations involving the use of derivative products, including futures, options and hedging instruments.

This type of arbitrage involves buying an asset in the spot market and simultaneously opening a short position in the perpetual futures market. The main condition is that the futures contract must have a positive risk premium.

Profitability in this case is formed by accruing interest at the funding rate. This is a special mechanism in the perpetual futures market, designed to ensure the correlation of the prices of the underlying asset and the futures contract. Funding rate refers to the fee for open long positions to traders who have short positions, and vice versa, depending on the price movement of the underlying asset. The funding rate is not an exchange fee and changes several times a day.

For example, the current funding rate for short positions on a BTC futures contract is 1%. In this case, the investor buys BTC in the spot market and opens a short position in the futures market for the same amount. Such a transaction is neutral, and the trader’s profit will be equal to 1%, which will be credited at the time of expiration of the futures contract (short position).

Benefits of Cryptocurrency Arbitrage

Despite the complexity and high requirements for working capital, arbitrage operations are strategies with minimal risk and virtually guaranteed income.

All costs and possible risks in the arbitration process must be included in the calculations before the start of operations. The trader does not need to guess the future prices of the asset – the benefit is derived from the inefficiency of the interaction of various platforms and instruments at a particular point in time.

Arbitration operations are an integral part fair market pricing on the stock exchanges. The practical benefit of such trading strategies lies in the alignment of asset prices in markets independent of each other, balancing prices to some extent.

Cryptocurrency arbitrage risks

In the process of applying any trading strategy, no matter how reliable it may seem, there are many obvious and hidden risks:

The complexity of the calculations. Arbitrage transactions involve complex mathematical calculations – one wrong variable can lead to loss of expected profits and even losses.
High commissions. Due to the low profitability of arbitrage transactions, even a small commission for transactions on the platforms used can lead to a loss of funds.
Low transaction execution speed. The constant volatility of the markets and the speed of transactions on modern exchanges require almost instant action from the trader. Even fractions of a second can change the situation and disrupt the profitable chain of speculative operations.
technical risks. The unpredictability of the reaction of market participants and the imperfection of the mechanisms used carry the risk of non-execution of orders, stopping trading or freezing the trading terminal at the most inopportune moment.
Low liquidity of the asset. This risk arises from the high working capital required to profit from arbitrage operations. The order book may not contain the required amount of funds at a certain price level, which will violate the settlement conditions and may lead to additional costs.

What is P2P cryptocurrency arbitrage?

The cryptocurrency trading market is becoming more organized, with price discrepancies across platforms getting smaller over time. Thanks to the centralized trading system through the glass and information of orders, the spread, that is, the difference between the sale and purchase price of an asset, is low or even minimal on the exchanges.

However, P2P services may present more arbitrage potential. The trading system there is decentralized, users carry out transactions directly and form prices. often based on individual needs. Offers to sell or buy the same cryptocurrency can differ significantly. Thus, P2P arbitrage of cryptocurrencies can provide more opportunities for generating income.

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Conclusion

Cryptocurrency arbitrage is a powerful trading strategy that can be used to take advantage of price differences between different exchanges. By buying and selling currencies on different exchanges at the same time, traders can quickly capitalize on price differences and make a profit. Although it can be a risky move, it can be a great way to make a profit if done correctly. With the right knowledge and tools, cryptocurrency arbitrage can be an effective way to make a profit in the cryptocurrency markets.

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