What Is Arbitrage in Crypto Trading?

What Is Arbitrage?

Arbitrage is a trading strategy that involves taking advantage of price differences for the same or similar financial instruments across different markets or platforms. Traders exploit these inefficiencies to generate risk-free profits by buying the asset in the lower-priced market and simultaneously selling it in the higher-priced one.

This concept is based on the principle of ‘law of one price’, which suggests that identical goods should sell for the same price in efficient markets. However, due to factors like market inefficiencies, transaction costs, or timing differences, price discrepancies may arise. Arbitrage trading helps align prices across markets, contributing to their overall efficiency.

There are several types of arbitrage, including:

1. Spatial Arbitrage: Taking advantage of price differences in different geographic locations or exchanges.
   
2. Triangular Arbitrage: Occurs in currency trading by leveraging exchange rate disparities between three currencies.
   
3. Statistical Arbitrage: Using advanced algorithms to identify patterns and temporary pricing inefficiencies.

While arbitrage is often considered low risk, it requires sufficient capital plus hardware and software that support fast execution, as opportunities are often fleeting due to high competition. 

Additionally, transaction fees and regulatory constraints can impact profitability. Arbitrage remains a cornerstone strategy for advanced and professional traders, particularly in financial markets like stocks, foreign exchange, and cryptocurrencies.

What Is Arbitrage in Crypto Trading and How Does It Differ From Traditional Arbitrage?

Arbitrage in cryptocurrency trading operates on the same core principle as traditional arbitrage — profiting from price discrepancies for the same asset across different markets. However, the unique characteristics of the cryptocurrency market create distinct opportunities and challenges.

Crypto arbitrage generally involves buying a cryptocurrency on one exchange, where its price is lower, and selling it on another exchange, where its price is higher. The decentralised and global nature of cryptocurrency markets, along with their high volatility, contribute to frequent price differences. Additionally, variations in trading volumes, liquidity, and fees amongst exchanges can amplify these discrepancies.

Key differences in crypto arbitrage include the 24/7 and faster-moving crypto trading market, and different regulations compared to traditional financial (TradFi) markets. While these factors can increase opportunities, they also can introduce risks like high transaction or gas fees if networks are congested at the time of execution. 

Successful crypto arbitrage requires advanced trading tools and a good understanding of the blockchains and tokens involved in the trade.

Is Arbitrage Trading Legal?

Arbitrage trading is legal in most countries and markets, and is widely considered a legitimate and beneficial trading practise because it enhances market efficiency by reducing price discrepancies. Arbitrage traders help align prices of the same or similar assets across different markets, which benefits the financial ecosystem as a whole.

While arbitrage itself is legal, activities like insider trading, front-running, or manipulating markets to create arbitrage opportunities are illegal and subject to penalties. Traders should familiarise themselves with the specific rules of the markets and jurisdictions where they operate to avoid potential issues.

Is Arbitrage Trading Risky?

Arbitrage trading can carry risks, despite its reputation for being a relatively low-risk trading strategy. While the principle of arbitrage is to exploit price discrepancies for near-risk-free profits, several practical challenges and market conditions can introduce risk.

Risks in Arbitrage Trading

1. Market Risk:
   • Price discrepancies may narrow or disappear before trades are completed, especially in volatile markets, resulting in losses.
     
2. Execution Risk:
   • Arbitrage opportunities often require fast execution. Delays due to slow trading platforms, network issues, or manual intervention can lead to missed opportunities or losses.
     
3. Liquidity Risk:
   • Insufficient liquidity in one market can prevent a trader from executing the required trades, making it impossible to capitalise on the price difference.
     
4. Transaction Costs:
   • High fees for trading, transferring assets, or converting currencies can erode or even negate potential profits.
     
5. Transfer Delays:
   • In cryptocurrency arbitrage, blockchain transfer times can create delays, during which the price difference may vanish.

Risk Mitigation

To minimise risks, traders generally:

• Use automated tools for faster execution.
• Factor in fees and delays when calculating profits.
• Diversify across multiple exchanges and markets.
• Monitor regulatory and market changes closely.

While arbitrage is often considered safer than speculative strategies, its success heavily depends on precision, speed, and effective risk management.

How to Start Arbitrage Trading

Traders start by identifying advantageous price differences and executing simultaneous buy-and-sell transactions to lock in profits. For instance, if Bitcoin is priced at $95,000 on the order books of Exchange A and $96,000 on the order books of Exchange B, a trader can buy it on Exchange A and sell it on Exchange B, earning $1,000 per BTC — or fractions thereof, depending on how much capital the trader can deploy. Traders must take into account potential fees on both exchanges, deducting from their gains.

To execute arbitrage effectively, traders must act swiftly, as price differences on order books are often fleeting. To start arbitrage, traders generally have to set up:

1. Accounts: Open accounts on multiple platforms or exchanges to access price differences.
   
2. Bots and Software: Many traders use automated trading bots or algorithms to monitor price discrepancies in real time.
   
3. Capital: Traders need sufficient capital to cover for the bid itself, transaction fees, and lag transfer times.

Many traders begin with small amounts to understand market dynamics before scaling up.

Simplify Arbitrage Trading With the Crypto.com Arbitrage Bot

The Funding Arbitrage Bot automatically executes arbitrage trading strategies, where users can potentially collect funding fees from the funding rate mechanism built into perpetual contracts while hedging market risk with the same underlying asset. Please note that the Funding Arbitrage Bots involve spot and perpetual futures trades. Users must be in jurisdictions approved for derivatives trading in order to create a Funding Arbitrage Bot.

The Funding Arbitrage Bot can set up both positive and reverse carry orders between spot and perpetual trading pairs, allowing traders flexibility however the market moves. A ​​positive carry strategy comprises a long spot and short perpetual contract, while a reverse carry strategy comprises a short spot and long perpetual contract.

Visit the FAQ page for detailed examples of each strategy and how it works. 

Below is how to set up the Crypto.com Arbitrage Bot:

1. Sign in or sign up to the Crypto.com Exchange.
   
2. Navigate to Trading Bots > Funding Arbitrage Bot > Create Arbitrage Bot.
   
3. Select the Trading Pairs to set up an arbitrage strategy and desired Funding Amount.
   
4. Click Proceed to review and confirm the order details for the Funding Arbitrage Bot, and accept the risk warning and applicable terms, then Confirm to launch it.

Conclusion

Arbitrage in crypto trading is a valuable strategy for leveraging price discrepancies across markets to generate profits. While it shares foundational principles with traditional arbitrage, the unique characteristics of the crypto ecosystem — such as its 24/7 operation, decentralised nature, and token-based transactions — offer both opportunities and challenges. 

With the right tools, preparation, and knowledge, traders can navigate the risks associated with market volatility, transaction fees, and execution delays to capitalise on these opportunities. As with any trading strategy, thorough due diligence and an understanding of the underlying assets are critical for success.

Due Diligence and Do Your Own Research

All examples listed in this article are for informational purposes only. You should not construe any such information or other material as legal, tax, investment, financial, cybersecurity, or other advice. Nothing contained herein shall constitute a solicitation, recommendation, endorsement, or offer by Crypto.com to invest, buy, or sell any coins, tokens, or other crypto assets. Returns on the buying and selling of crypto assets may be subject to tax, including capital gains tax, in your jurisdiction. Any descriptions of Crypto.com products or features are merely for illustrative purposes and do not constitute an endorsement, invitation, or solicitation.

Past performance is not a guarantee or predictor of future performance. The value of crypto assets can increase or decrease, and you could lose all or a substantial amount of your purchase price. When assessing a crypto asset, it’s essential for you to do your research and due diligence to make the best possible judgement, as any purchases shall be your sole responsibility.