What Is Cryptocurrency Arbitrage And How Does It Work?

Amanda SchillerSunday 26 September 2021
Cryptocurrency coding digital background vector open-source blockchain concept

Cryptocurrency is one of the most exciting topics in the financial world today. It feels as though almost every day there are new updates in regards to soaring/crashing cryptocurrency prices, regulations, or new coins that are being mined. There are also plenty of success stories of people who have used cryptocurrencies to get rich.

When it comes to profiting off cryptocurrencies, one of the most common ways to make money is through a process called cryptocurrency arbitrage.

In this article, we will take a look at just what exactly cryptocurrency arbitrage is and how it works.

What is cryptocurrency?

If you’re not familiar, cryptocurrency is a secure form of digital payment that exists entirely online. One of the main purposes of cryptocurrencies is to allow digital transactions to take place more easily. Instead of having to wait several business days for your money to transfer bank accounts, the transfer can be done instantly using cryptocurrency.

However, cryptocurrency prices are also incredibly valuable. This has caused lots of investors to buy cryptocurrencies in hopes that their prices will increase over time.

According to Nerdwallet, there are about 10,000 different cryptocurrencies currently in circulation. The current value of all of these cryptocurrencies is just over $2 trillion.

The most common cryptocurrency is Bitcoin, whose price started 2020 at around $8,000 before rising to $60,000. So far in 2021, Bitcoin’s price has dropped to $30,000 before rising again to $50,000. If you can time these rises and falls consistently, you can make a lot of money in cryptocurrency.

However, there are also other ways to make money in cryptocurrencies.

Cryptocurrency exchange design elements vector set

What is arbitrage?

Arbitrage is defined as a trading strategy where investors search for assets that are priced differently across different exchanges. By simultaneously buying them on one exchange and selling the same quantity on another exchange, traders can profit off the differences in the asset’s price.

One example of how this process works in the real world is looking for products at yard sales that you’d be able to resell at a higher price elsewhere. For example, let’s say you go to a yard sale and find an Xbox 360 that they are selling for $100. You check eBay and see that most Xboxes sell for $150 on this site. Theoretically, you would be able to buy the Xbox for $100 at the yard sale and resell it for $150 online, profiting $50.

This is how arbitrage works, and it’s incredibly common with most assets. In particular, traders will take advantage of fluctuations in currency rates in order to profit from this strategy.

The most recent place this strategy has become popular is cryptocurrency.

How does cryptocurrency arbitrage work?

Cryptocurrency arbitrage is simply the combination of these two practices. Cryptocurrency arbitrage is when you look for differences in the prices of the same coin across different exchanges.

For example, let’s say that you notice that the price of Bitcoin is slightly cheaper on Coinbase when compared to Binance. You could technically buy Bitcoin for a cheaper price on Binance and then almost instantly resell it on Coinbase for a profit.

Most investors will assume that markets are efficient and assets are fairly priced. While this may be true for larger exchanges like the New York Stock Exchange, it’s not always true for cryptocurrency exchanges.

There are a few reasons why this is:

  1. Most cryptocurrency exchanges, especially smaller ones, don’t have nearly the volume that stock and currency exchanges do. This means that prices take a little bit longer to average out.
  • There are different types of exchanges for both retail and institutional investors.
  • Withdrawal and deposit times vary across exchanges. This means that some exchanges catch up to market prices more quickly than others.
  • Cryptocurrencies are available globally. However, supply and demand varies by country.

Pros and cons of cryptocurrency arbitrage

A few pros of cryptocurrency arbitrage is that it’s very low risk, is easier in volatile markets (i.e. most cryptocurrency markets), and allows you to make money regardless of which way the market is going.

That being said, there are a few cons to this method as well. Namely, transaction fees can start to add up and eat into your profits, prices are incredibly unpredictable, and there’s always the potential of losing money.

Please keep in mind that cryptocurrency prices are incredibly volatile and are known to rise and fall by a significant amount in a very short time frame. Due to this, you should use also caution whenever you are buying, selling, or in cryptocurrencies.

We hope that you’ve found this article valuable when it comes to learning what cryptocurrency arbitrage is and how it works! If you are interested in learning more, please subscribe below to get alerted of new articles as we write them!



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