Crypto arbitrage in 2022: a full guide for beginners
While some people keep criticizing the cryptocurrency market for its volatility, high risks and overvaluation, others make money on it. Working with crypto is definitely not that easy because it doesn’t obey usual financial laws and rules.
Decentralization and minimal regulation is reflected in the differences in rates of crypto on exchanges. All this opens up opportunities to make good money from arbitrage.
How does cryptocurrency arbitrage work?
Unlike standard financial transactions, crypto is not regulated by official organizations. There are no fixed rates, like in banks – everything is decided by supply and demand at a particular moment in time. Transactions to sell, exchange and buy cryptocurrencies go through exchanges – there are more than 300 of them now.
Despite general market trends, rates vary from platform to platform. For example, the difference in bitcoin offerings can be as much as $100. Differences can be not only within pairs of fiat currencies and crypto, but also within crypto pairs. For example, when exchanging BTC to ETH and recalculating in dollars, there will be different numbers than when exchanging BTC to Cardano.
Arbitrage specialists make money on these price discrepancies across different exchanges.
Why are exchange rates different on different exchanges?
All speculative earning strategies involve financial risks. To reduce the risk of losses, you need to understand the intricacies of the work and the differences between exchanges. For example, there can be low commissions for operations, but withdrawal of money is available only to the accounts in the country where this particular organization is registered. This can lead to losing your money.
The first thing you need to understand when starting with arbitrage is the reasons behind this price differences:
Trading volume: the more coins that can be exchanged, the more frequent the transactions, the lower the prices.
Decentralization: there is no single system where you can cooperate and make decisions, which means that it’s more difficult to adjust rates.
Deficits: if an exchange doesn’t have enough of a certain cryptocurrency to exchange, this particular cryptocurrency can go up in price. Scarcity can push prices up.
Server locations and government regulation: The country’s environment can also affect the rate. Although it’s usually considered that crypto can only be analyzed technically, in practice the fundamental indicators also affect its dynamics.
Rules of the particular exchange: available withdrawal methods and withdrawal speed, commission rate, conversion methods – all this affects rates.
That’s why you should learn more about the particular exchange and read all the conditions to build your earning strategy. The amount of commissions is essential for planning, and in order to minimize the risks it’s necessary to clarify the details related to the regulation of the industry in each country.
Another factor that affects crypto prices is speculation. For newcomers, these can turn into a trap, because all technical schemes stop working. To avoid mistakes, you either need to team up with other traders or dive into the industry by yourself. As an example, let’s take a look at one of the most popular speculative strategies – pump & dump.
Pump & dump
This is a simple way of speculation that despite its simplicity works really well. Arbitrageurs who know the insights or can predict such a situation on the market, can make a quick profit. The logic is based on purposefully inflating the price of the cryptocurrency, which is usually not the most popular one at the moment: traders pick a coin and start buying it up at low prices. The exchange rate begins to rise. Misinformation is spread through digital channels and media outlets, touting the currency’s prospects. Outsiders and newcomers read these articles and buy crypto following speculators. The stakes rise even higher.
At the peak, pampers begin to sell the currency sharply and curtail its advertising. The rate collapses and the people who bought it at high prices can’t recoup their investments. Usually after the dump, the chart fails below the original point when the pump first started.
Crypto arbitrage specialists make a lot of money on this, but it’s important to consider the risks and conduct transactions quickly. Constant monitoring of indicators and charts are necessary, and preferably – working in a group with other pumpers.
Types of arbitrage
Earnings from cryptocurrency arbitrage should be based on a clear and precise strategy – the trader needs to consider the risks and think through the tactical steps if something goes wrong. First of all, it is crucial to define the basis, which includes the type of arbitrage.
Classical type
This strategy involves working with two currency pairs. Here, it doesn’t matter if the coins are interdependent – only the instant profit is taken into account. Transactions can be conducted on one exchange or on several ones. Actions always occur in a chain – only its length and the exchange platforms may change. A typical scheme looks like this: a trader buys bitcoin on one cheaper platform and resells it on another, where prices are higher. You earn by changing pairs within the exchange – for example, USD to BTC, BTC to ETH, and at the last stage you go back from ether to dollar.
A hybrid model, which includes several currency pairs and exchanges
The scheme often uses correlating coins, such as bitcoin with LTC or XMR. The growth of one rate may overtake the growth of the other, and trades are made on this gap.
Static
The main difference of this type is that the correlation between coins is factored into the strategy. The basis is market inefficiencies, which make a space for technical gaps. In correlated currencies such a gap occurs less frequently, but one can find ideas for arbitrage everywhere. The odds charts, which are constantly changing, help with this too. When you find a ready-made one on the Internet, be sure to check its relevance. They look like this:
To make a profit, you need to properly calculate what ratio can pay off. When making a comparison, take a look at the direction of the price of the asset: if the correlation coefficient is greater than 50% or 0.5, then multidirectional trends will yield profits; if currencies are less dependent on each other, ideas for earning should be sought in volatility indicators. It’s much more difficult to analyze the market situation and find such situations, so static strategies are not recommended for beginners. This is usually done by experienced traders who use their own systems and tools for searching.
Intra-exchange arbitrage
For cryptocurrency arbitrage purposes, traders can use one or several exchanges. The choice affects the logic of calculations, so it’s necessary to consider it in both classical and static strategy. For beginners, at the first stage, it’s better to make transactions within one platform, because there are less calculations. This will help to understand the logic behind it.
The basis of profit is the price discrepancies within several currency pairs:
- Depositing fiat on the exchange, for example, USD
- Buying BTC
- Exchanging BTC for XMR
- Selling XMR and receiving USD
If you have more dollars at the fourth step than you had at the first one, you are in the black. But that’s not enough to make correct calculations, because you need to take into account the commissions. Even if you work with one exchange, you will pay commissions for depositing fiat currency on the exchange, for buying and for withdrawing money.
Another type of earning is hedging as in standard trading. The spot asset has a lower price than the futures contracts, so you buy it and sell the futures. The price gap tends to zero by the expiration date, so you can make a profit on this gap. The risks are lower, but the income is not so high.
Inter-Exchange Schemes
There are more opportunities for profitable trading when there are several exchange platforms involved. Calculations in these schemes are more complex. To be profitable, you need to consider five types of commissions:
- crediting of fiats
- purchase of cryptocurrency
- transfers between exchanges
- sale of coins
- withdrawal of money from the exchange
Often these commissions eat up all the inter-exchange inscrepancies, making these transactions meaningless. However, sometimes you can find such gaps that will give you a good profit, despite all the commissions.
The standard way
Let’s analyze the scheme using bitcoin as an example:
Step #1. Comparing rates on different exchanges
If you find a big gap, for example, $500, you can start considering a trade.
Step #2. Get all the information about commissions and about the platform
At this step you need to simulate the situation and calculate the amount of commission for each transaction. Read the withdrawal rules of the particular exchange – it’s important to understand whether you can withdraw your money and how long it will take.
Step #3. Buying cryptocurrency at a low price
You need to convert USD to BTC on the exchange where the rate is lower.
Step #4. Transfer to another exchange
Get prepared for a sale transaction – you need to transfer the asset to the exchange platform where the price of crypto is higher.
Step #5. Selling at a high price
You convert BTC for USD at a good exchange rate and either withdraw the fiat or start the cycle all over again. In this scheme, arbitrage earnings are counted as follows: you subtract the discrepancies between the exchange rates and subtract all costs from the amount. Take into account that you need to count commissions step by step, that’s why it’s better to split all operations into steps and analyze every transaction separately. Take into consideration the risks of change in quotes – volatility of crypto is much higher than of other financial instruments, so prices may change in the process of inter-exchange transfer.
50/50 scheme
This method involves spreading assets across multiple platforms – there can be many of them. Let’s take a look how it works when using two platforms at once:
- You have cryptocurrency pairs, such as BTC and ETH, stored on both exchanges.
- When you see a gap of 5% or more, you make two transactions – on one platform you sell one of the elements of the pair, and on the other you buy it.
- You end up with one crypto remaining on each, but on one you will have 100%, and on another – 105% due to the gap.
- Then you redistribute them between platforms so that the ratio is again 50/50.
Pros of crypto arbitrage
If an arbitrageur has technical and fundamental financial analysis skills, it will be easy to work in the niche. By studying charts, you will be able to find successful entry points. However, at the start it’s not necessary – it’s enough to be able to count and compare numbers.
Besides the simplicity at the first stage, this way of earning has other advantages:
- Small investments at the start
- Quick profits
- The short terms of operations – some platforms process requests instantly
- Several cycles can be conducted during the day
- Managing risks by choosing various strategies
It’s not necessary to have formal training, because it’s easier to understand many things in practice. There are hardly any perfect courses where all the details are explained, because the industry is new, the market is changing and the information is constantly changing as well.
Cons and risks
The main problem is the novelty of the niche. There is not yet enough data and stable trends to make objective conclusions. Therefore, a crypto arbitrageur needs to stay constantly in the loop: monitor news, compare different points of view, test tools.
Another disadvantage is the commissions. For transactions, the commission is calculated on the total amount, so the gaps must be big enough to cover the amount of all commissions. If you consider working with bitcoin, you need more investments at the start – from $1500-2000. At the same time, you should withdraw money from exchanges regularly, because they don’t have such a high level of protection. Reports of hacking and thefts from wallets can be found on well-known exchangers with thousands of reviews, so it’s risky to keep your assets there for a long time.
There can be some difficulties due to time frames of the transfer. While you’re making a transfer, the price of the purchased crypto can fall and you will lose money. To avoid this, you need to analyze the reasons behind the gaps and carefully study the platform’s terms and conditions.
How to minimize risks
1. Make decisions with a cold head
Overconfidence leads to bad consequences, so it’s highly important to calculate the risks for each operation. That’s why you should always monitor changes in terms and conditions, because commissions can change as fast as currency rates. Keep everything under control.
2. Verify your account as soon as you sign up
An unverified account must be verified anyway. If you don’t verify it in the beginning, later on when you might want to withdraw your money, this procedure will cause you delays in the operations. Sometimes blocks are not removed for weeks, despite all attempts to reach the support team.
3. Test how quickly the crypto is transferred to your account after the exchange
The real time frames might differ from the one indicated on the exchange. You should take into account the time risks associated with rate changes during the day.
4. Consider liquidity
Evaluate how quickly and efficiently the assets can be converted to fiats or bitcoin. Your trading volume affects your earning power – sometimes you buy crypto at a good rate, but it’s hard to cash it out.
5. Keep in mind the opening hours of exchange platforms
The market is more active at this time, which means more opportunities for profitable arbitrage.
- One trade should not exceed 10% of your total cryptocurrency volume
10% is a reasonable level of risk, which allows you to earn, and in case of losses will not lead to disaster.
Also, seasoned crypto arbitrage specialists recommend making your own spreadsheets and putting in all commissions and price discrepancies. You can do this with simple, consistent formulas in Excel. The price difference that is worth working with is usually 5%, but if the commissions are low, you can make some good money with 2% as well.
Choosing a crypto platform
Three criteria are important for cryptocurrency arbitrage: liquidity, commissions and number of pairs for exchange.
How to evaluate liquidity?
This can be assessed by the volume of trades and the number of users. Turnover is important, because if there are not enough coins or buyers, you will not be able to conduct a transaction. The longer the coins are in the transaction order, the bigger the risk is. You can check the up-to-date information regarding liquidity from the rating on Coinmarket website.
What does the number of cryptocurrency pairs affect?
Diversity gives more opportunities for arbitrage. It’s important to look not just at the number of pairs, but also at the capitalization within each of them – if no one wants to exchange XMR for ADA, nothing will work. Big price differences and minimal commissions will not save the situation.
With low volumes within a pair, a sudden jump in rates not in your favor can become a problem. The longer a seller waits, the more the losses are. Therefore, when working with new currencies, it’s highly recommended to test approaches on small sums and take into consideration the volume of a particular coin on the exchange.
Optimizing Commissions
Make summary tables with commissions for different currencies and exchanges. Sometimes a commission for converting to dollars is higher than for converting to rubles or euros. If you don’t care about fiat currency, you can trade with higher profits. Interchange transfers are more profitable in less popular coins, because the commissions are lower.
Useful Services
Despite the fact that it’s better to analyze the market by yourself, some arbitrage processes can be automated. There are scanners, bots and programs for comparing exchange rates for this purpose. Check these out:
Cryptolume
A scanner with a big database of thousands of crypto coins and notifications when there are price differences. The program performs calculations automatically, showing only profitable offers.
Bitsgap
A bot that downloads information from different sources and allows you to make automatic trades within thousands of cryptocurrency pairs. There are many additional features to help you analyze the market and protect assets.
BitInfoCharts
A useful service with rate comparisons when you develop a strategy. It shows cryptocurrencies and fiat money prices. The interface is not the most up-to-date, but it’s convenient to work with tables.
Cryptowatch
Here you will find tables with pair correlations. Graphs can be built based on data for different periods – day, week, month or year. Many useful tables and charts for trading and arbitrage can be found on the website.
Actually there are many other platforms that help arbitrageurs. But no matter how well the services work, you should double-check the data before starting trading. Sometimes data updates are late, and even the most advanced bots can have glitches. The risks and responsibility for the assets are still on you.
However, there are other ways to make money on crypto. For example, you can connect to affiliate programs and attract clients to exchanges, receiving commissions after the first transactions or some other user’s actions. This model has less risks for beginners, and CPA marketing has proved its high profitability. You can find more than 2000 affiliate programs in the Indoleads catalog. Take a look at some of our crypto offers:
Binance Affiliate Program (US)