Bitcoin Arbitrage: Is It a Profitable Crypto Investment Strategy?
Bitcoin has become a popular and accessible target for investors, and there are countless ways of actually making an investment. Some investors prefer to play things safe and make long-term investments in various cryptocurrencies. Others prefer riskier and fast-paced investment models, such as day trading. However, one investment method that is not widely discussed is arbitrage, a traditional investment strategy that is making its way into the crypto world. This guide will explain the pros and cons of Bitcoin arbitrage in order to help you decide if the method is worthwhile in your situation.
- What is Bitcoin Arbitrage?
- Bitcoin Arbitrage Strategies
- Factors to Consider
Arbitrage simply involves buying an asset, in this case Bitcoin, and selling it immediately at a higher price. In some ways, this resembles short selling, which involves anticipating changes in a coin’s overall market value so that you can sell it at a profit. But unlike short selling, arbitrage does not involve anticipating a coin’s future value — it involves looking for price disparities across different exchanges at the same time.
For example, if you look up Bitcoin on a market data aggregator, you will find the coin’s market price. Although that price is very close to what you will find on most exchanges, it is not exact. Each exchange prices Bitcoin differently depending on various factors. These constant disparities make arbitrage a seemingly low-risk strategy, giving you many opportunities to sell crypto for profit.
Since exchange prices are constantly changing, you should always be able to find an exchange that will buy your Bitcoin for more than you originally paid — at least in theory. However, the process is not as simple as it seems at first glance. There are a number of arbitrage strategies, each with its own benefits and shortcomings. Here are a few approaches:
Many exchanges allow you to instantly move your crypto holdings between exchanges. Any crypto token can be used for arbitrage, but let’s consider Bitcoin in this example.
If there is a significant difference between Bitcoin prices on two exchanges, arbitrage becomes a possibility. Consider trading Bitcoin and Ethereum in this situation:
|Exchange A||1 BTC ⇆ 36 ETH|
|Exchange B||1 BTC ⇆ 37 ETH|
You would be able to purchase 1 BTC on exchange A for 36 ETH, then sell it on exchange B for 37 ETH. Of course, 1 BTC is a fairly large investment — about $4000 at the moment. But if you did make the investment, you would make a profit of 1 ETH — over $100 at time of writing.
This is a simple example: more complicated strategies such as triangular arbitrage also exist. But even the simplest strategy introduces a number of problems. Even though many exchanges provide instant cross-exchange crypto transfers, some exchanges will correct their prices too quickly for you to perform arbitrage.
Furthermore, even if you manage to sell coins at a profit a few times, you will undoubtedly miss an opportunity at some point. You may still get a reasonable exchange rate and minimize your losses, but in general you should seek out exchanges that do not adjust their prices quickly.
Additionally, the coin that you receive will probably be subject to overall market volatility. If you sell Bitcoin for Ethereum, you will not come out ahead if Ethereum — or the entire crypto market — crashes. However, selling crypto for stablecoins like Tether may provide a limited amount of protection against volatility.
Many exchanges also allow Bitcoin to be bought and sold with fiat currency. Consider this situation:
|Exchange C||1 BTC ⇆ $3700|
|Exchange D||1 BTC ⇆ $3800|
A $100 disparity offers a significant profit, assuming you can afford to buy nearly $4000 worth of Bitcoin. This level of disparity is fairly common, but even larger disparities occurred in January 2018, when Coinbase sold BTC at $15,255 and Upbit sold BTC at $22,674.
Suggested Reading : See why Coinbase is one of the top Bitcoin exchanges.
Actually exploiting these opportunities is difficult, as time is a major obstacle in crypto-fiat arbitrage. It can take several days to transfer fiat currency to and from exchanges. Domestic exchanges take a few days to handle fiat currency, and international exchanges can take even longer.
If you have previously invested in several different types of crypto, or if you have already deposited funds in several different exchanges, you may be able to quickly take advantage of almost every arbitrage opportunity. However, this would be a very large investment.
Additionally, foreign exchange rates, bank fees, and exchange fees can cost hundreds of dollars and eat into your profits, meaning that crypto-fiat arbitrage is not particularly viable.
Although it is not technically arbitrage, one strategy involves selling Bitcoin on peer exchanges such as LocalBitcoins and Paxful. This method can be considered “flipping,” as you will need to put substantial effort into finding a buyer.
Unlike regular exchanges, peer exchanges allow users to sell coins at their own rates, which are almost always higher than market rates. However, buyers greatly outnumber sellers, resulting in plenty of competition between sellers. Yet this method does provide one advantage: setting your own rates protects you against market fluctuations and removes the pressure to act fast.
But in order to attract customers who are willing to pay high prices, you will need to have an excellent reputation or accept niche currencies and payment methods. Whereas regular exchanges will almost always buy crypto from you, there is no guarantee that anyone will buy your Bitcoin on a peer exchange.
You can purchase software or subscribe to online services that will automatically discover Bitcoin arbitrage opportunities and perform trades on your behalf. However, these services will almost certainly cost you money or take a cut of your profits.
Additionally, some services that offer automated arbitrage trading may not be legitimate. Beware of sites that promise high returns or other offers that are too good to be true, as these are likely to be scams.
Alternatively, complex trading platforms such as SFOX can automatically provide you with in-depth market information, but will let you decide which opportunities to exploit on your own. This means that only the first step — collecting information — is done automatically, leaving you to invest your funds safely on your own terms.
By now, it should be clear that it is difficult to perform Bitcoin arbitrage consistently. As such, you should consider several factors before you consider arbitrage as a serious strategy — and certainly before you take any opportunity that arises. Here are a few things to consider:
- Transfer times: If exchanges take too long to handle fiat currency or crypto assets, you could miss out on a Bitcoin arbitrage opportunity, even if you notice it right away. You should become familiar with exchanges and find out how quickly they adjust their prices when a disparity exists.
- Market uncertainty: If you are selling Bitcoin for another cryptocurrency, market volatility will probably affect any crypto coin that you end up with, including stablecoins. However, this is a double-edged sword: variations in the crypto market can also cause the disparities in pricing that you need in order to profit.
- Exchange turmoil: In addition to market variations, price differences exist when exchanges are in turmoil. These troubles are often caused by sudden regulatory changes in different countries. Some commentators have argued that the best arbitrage opportunities have disappeared over the past year due to exchanges becoming more stable. However, less extreme factors like technical difficulties, security risks, and bad press coverage can also create price disparities.
- Certainty of transactions: The possibility that you will be unable to sell your coins is mainly an issue on peer exchanges. However, traditional exchanges will sometimes suspend trades, deposits, and withdrawals in the event of a market crash, security risk, or technical difficulties.
- High investment requirements: Fees imposed by banks and exchanges can easily eat away at your profits. This is mainly a problem for crypto-fiat arbitrage, but exchange fees will also apply to arbitrage performed entirely with crypto. The result is that you may have to invest thousands of dollars to avoid being gutted by fees.
- Exchange restrictions: Even if you can afford to invest thousands of dollars, exchanges may put restrictions on large trades. Sometimes new users are only able to trade a limited amount of funds. Furthermore, exchanges with small trading volumes may prevent anyone from trading large amounts. This means that exchange prices alone will not determine whether your Bitcoin arbitrage attempt will be successful.
- Improved synchronization: In traditional finance, many arbitrage opportunities have disappeared in recent years, as exchanges are becoming better at aligning asset prices and fixing pricing errors. As the crypto market grows and the underlying technology becomes more advanced, crypto exchanges may similarly become more synchronized. This will eliminate many unintentional price disparities, thereby reducing arbitrage opportunities.
Bitcoin arbitrage may be a worthwhile strategy if you can do the research that is necessary to find optimal trading opportunities. Even though arbitrage escapes some of the risks that other investment strategies suffer from, it nevertheless depends on market conditions and real-world forces, which produce pricing disparities between exchanges.
Although some arbitrage opportunities truly are golden, hidden costs and exchange policies will make or break how consistently you can execute your arbitrage plans. As regulations tighten around crypto exchanges, and as exchanges become more stable and established, Bitcoin arbitrage may become decreasingly viable. Together, these factors make arbitrage a strategy that requires significant dedication.
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