Arbitrage Trading
Arbitrage Trading is basically a type of trading opportunity in which a trader capitalizes on the price differences between two or more exchanges to make profit. In Arbitrage Trading, a trader buys a cryptocurrency asset on an exchange at a particular price and sells the same cryptocurrency asset on another exchange at a higher price to make profit with very minimal risk, or an investor buys a cryptocurrency asset on a particular cryptocurrency pair and sells the same cryptocurrency asset on another cryptocurrency pair to make profit.
This is common in the cryptocurrency space as sometimes the price of a particular cryptocurrency is higher on Okx than the price on binance. when this arises, a trader can quickly buy the cryptocurrency at a cheaper price on binance and quickly sell it on Okx at the higher price to make quick profit. Also, Arbitrage Trading is also common on crypto pairs. Sometimes, the price on a particular cryptocurrency pair is much lower than the price on another cryptocurrency pair. A trader would capitalize on these price difference for quick profit while taking minimal risk.
When it comes to arbitrage trading in the crypto space, the two very common types are; exchange arbitrage trading and triangular arbitrage trading.
Exchange arbitrage trading
This type of arbitrage trading is very popular and is also seen in the crypto space. Exchange arbitrage trading is basically a trading that involves buying a particular cryptocurrency on a crypto exchange at a lower price, and selling the same cryptocurrency on another crypto exchange at a higher price. At the moment, there are numerous crypto exchanges which can sometimes have different prices between two or more. In exchange arbitrage trading, a trader spots the price differences between two exchanges and capitalizes on the price difference to make quick profit.
Triangular arbitrage trading
This type of arbitrage trading is also very popular and is also seen in the crypto space. Triangular arbitrage trading is basically a trading that involves capitalizing on the price differences between multiple crypto pairs. In triangular arbitrage trading, a trader sells a particular cryptocurrency for another cryptocurrency, sells that for another cryptocurrency and finally selling that cryptocurrency for the first cryptocurrency to make profits by having more quantity.
Benefits of Arbitrage Trading
Low-Risk - The risk level that is involved in Arbitrage Trading is very low that is why it considered as a very safe trading by a lot of traders. All the trader needs to do is to be quick enough to spot and capitalize on the price difference either on different exchanges or different crypto pairs, because the price differences might not last long if other traders discovers the opportunity too.
Quick profit - This is one of the main benefits of arbitrage trading. A trader can make quick profits if he is quick enough to capitalize on the price differences between two exchanges or two crypto pairs.
Illustration of How to Take Advantage of Exchange Arbitrage and Triangular Arbitrage in Cryptocurrency
When there is an Exchange Arbitrage opportunity, a trader spots the price difference between two exchanges, the trader must be quick to capitalize on the opportunity to make quick profit. To demonstrate exchange arbitrage, I will be making use of an illustration to demonstrate how to capitalize on Exchange Arbitrage.
Let’s take for instance on binance exchange, the price of MATIC on the USD pair is $1.02 and on Okx exchange, the price of MATIC on the USD pair is $1.18. A trader who is fast enough to spot the price difference between the two exchanges will quickly capitalize on the opportunity.
To illustrate this;
Price of MATIC on binance Exchange - $1.02
Price of MATIC on Okx Exchange - $1.18
The trader Buys 5000 MATIC on binance exchange at the price of $1.02
5000 x 1.02 = $5,100 which is the cost of buying 5000 MATIC.
The trader quickly withdraws the 5000 MATIC to Okx exchange using exchange to exchange
The trader Sells the 5000 MATIC at the price of $1.18
5000 x 1.18 = $5,900 which is the value the trader gets after selling.
To get the profit the trader would do $5,900 - $5,100 = $800
From this, the trader has made an $800 profit.
Depending on the quantity of coins traded, even if trading fees and withdrawal fees are included, the trader will still be in profit.
Triangular Arbitrage in Cryptocurrency and How to Identify Triangular Arbitrage Opportunities and The Risks Involved
Like the name triangular, it basically shows that there are 3 steps involved in the trading triangle. Triangular arbitrage trading involves capitalizing on the price differences between three cryptocurrencies pairs. In triangular arbitrage trading, a trader sells “cryptocurrency A” for “cryptocurrency B”, sells that “cryptocurrency B” for “cryptocurrency C” and finally sells that “cryptocurrency C” for the first “cryptocurrency A” to make profits by having more quantity. The trader can sell the extra coins to earn a profit.
From the illustration diagram, the trader already had MATIC coins. The trader discovered that there is a Triangular Arbitrage opportunity between the MATIC/ETH, BNB/ETH and MATIC/BNB pairs, so the trader capitalized on the opportunity.
Price of MATIC on the MATIC/ETH pair - 0.00037425 ETH
Price of BNB on the BNB/ETH pair - 0.1242 ETH
Price of MATIC on the MATIC/BNB pair - 0.002917 BNB
The trader already has 5000 MATIC
The trader sells 5000 MATIC for ETH at the price of 0.00037425 ETH.
The trader receives 1.871250 ETH
The trader sells 1.871250 ETH for BNB at the price of 0.1242 ETH.
The trader receives 15.0664 BNB
The trader sells 15.0664 BNB for MATIC at the price of 0.002917 BNB.
The trader receives 5,165.03 MATIC
To get the profit, 5,165.03 MATIC – 5000 MATIC = 165.03 MATIC
The trader has made a profit of 165.03 MATIC
Risk involved in Triangular Arbitrage
While the Triangular Arbitrage can be very profitable if done right, there are also some level of risk involved. Some of the risk involved in Triangular Arbitrage are;
Price Increase on the middle cryptocurrency pair
The cryptocurrency market is very volatile and anything can happen due to various factors. Since triangular arbitrage involves 3 cryptocurrency pairs, there is a risk of price of the middle cryptocurrency pair increasing against the first, causing the trader to have lesser quantity of the initial cryptocurrency. For instance, using my illustration above, the price of BNB/ETH increased to 0.1305 ETH which gives the trader 14.3390 BNB. After trading 14.3390 BNB to MATIC at the price of 0.002917 BNB on the BNB/MATIC pair, the trader receives 4,915.67 MATIC. This puts the trader at a loss of 84.33 MATIC.
Price slippage
This is one of the main risk involved in triangular arbitrage. Because of the volatility in the crypto space due to various factors, slippage can occur at any time. Slippage basically occurs when there is a quick change price between the price the trader is expecting and the market price. For instance, using the figures from my illustration above, the trader uses the market order type to sell 15.0664 BNB for MATIC at the market price of 0.002917 BNB. However, before execution, the a market price of MATIC on the MATIC/BNB pair changes to 0.003021 BNB and the sell order executes, 0.003021 BNB, which give the trader 4,987.22 MATIC. We can see that the trader has now made a loss of 5000 MATIC - 4,987.22 MATIC = 12.78 MATIC. The trader has now lost 12.78 MATIC on the triangular arbitrage.
When it comes to cryptocurrency investment, diversification is very important. It is a very effective risk management and investment strategy that can not only help reduce risk and losses of capital but can also help maximize profit. When it comes to cryptocurrency trading, Arbitrage trading has proven to be a very quick way for the quick and smart traders to capitalize on the price difference between two exchanges or multiple crypto pairs to make quick profits. However, while Arbitrage trading can be very profitable with minimal risk, there are also risk involved. That is why it is important for a trader to be very smart, careful and make the best decisions when venturing into arbitrage trading.
