Crypto Arbitrage: Complete Guide to Making Low-risk Gains

Whenever we talk about earning money in the crypto market, we often think of concepts such as buying crypto at a lower price and selling at a higher price to earn a profit. But is that the only way to profit from the crypto market? 

The answer is, obviously, no. Crypto trading offers numerous ways to benefit you financially. If you are interested in crypto trading but are overwhelmed by different trading concepts and risk management strategies, crypto arbitrage might be something you should look into.

Crypto arbitrage refers to a trading strategy in which traders take advantage of different exchange rates for the same digital asset. Generally, crypto exchange rates differ from one to another due to the differences in supply and demand. You can make use of these price differences to make a low-risk profit in the crypto market. 

Unlike regular trading, which may require knowledge of fundamental analysis, technical analysis, or sentiment analysis, crypto arbitrage trading is relatively straightforward. 

The only thing that matters is catching crypto arbitrage opportunities and acting on them quickly. Because cryptocurrency rates and prices fluctuate every second, a price drop or rise is always possible. So, the most crucial aspect of conducting cryptocurrency arbitrage is being alert and quick. As you embark on your journey to learn arbitrage trading, the key is to capture the price difference before it vanishes.

There are several different types of crypto arbitrage depending on how the arbitrage is done. The following are the most common among crypto investors:

1. Cross-exchange Arbitrage 

Crypto cross-exchange arbitrage is the process of making a profit by capitalizing on price differences of a particular asset on different crypto exchanges. Crypto arbitrage between exchanges is conducted on different platforms offering non-matching prices.

We can split cross-exchange arbitrage into three categories:

I. Standard Arbitrage

Standard cross-exchange arbitrage trading entails buying and selling currencies on two exchanges to profit from the inherent price differences from minute to minute. It takes advantage of price fluctuations to make a quick profit. 

Let's understand this crypto arbitrage strategy better with the help of an example of KuCoin and Binance arbitrage:

We have compared the prices of numerous cryptocurrencies on different cryptocurrency exchanges and spotted a spread in the price of Bitcoin on two exchanges. 

• KuCoin: BTC price at $21,200

• Binance: BTC price at $21,000 

A simple example of crypto arbitrage between exchanges would be to catch the price spread by purchasing 1 BTC on Binance and selling it on KuCoin simultaneously. It would net us a quick, risk-free profit of $200 minus trading fees. However, this has to be done extremely quickly, as the price differences even out in minutes or seconds.

This example, featuring leading crypto exchanges KuCoin and Binance, is extreme. Their high liquidity and mature market price mechanisms make a $200 price gap highly unlikely in reality.

Arbitrage traders often hold funds on multiple exchanges and trade by connecting their exchange account API keys to automated trading software in order to spot and catch such price differences as quickly as possible. Some experienced traders also use a cross-exchange arbitrage bot to automate this strategy and maximize their profits.

II. Spatial Arbitrage

Spatial cross-exchange arbitrage is a version of standard arbitrage but with one small twist: the exchanges are located in different regions. For instance, South Korean exchanges often have significant price premiums due to hype among regional investors toward certain tokens. One such spatial arbitrage opportunity was evident in July 2023 when Curve Finance (CRV) traded at a premium as high as 600% on Bithumb and 55% on Upbit following an exploit of the DeFi protocol's liquidity pools. 

While global exchanges often have very similar prices, exchanges that target specific regions are often trading at a premium or a discount. You can then use these price disparities to make a profit. 

The only downside of this method is that local exchanges often have restrictions in terms of who can sign up, as they enable trading in a smaller region.  

III. Decentralized Arbitrage

Decentralized crypto arbitrage occurs when the price of a certain crypto on a decentralized AMM market differs greatly from the spot market on regular exchanges. 

Decentralized exchanges use Automated Market Makers (or AMMs) instead of order books. The AMM in DEXs sets the asset price in each liquidity pool by analyzing its internal supply and how it balances with its trading pair. This means that the price of an AMM changes automatically based on demand within its own closed ecosystem. 

Because the closed DeFi ecosystem and its circumstances affect the price, you can capitalize on the price difference by buying a crypto on a DEX and selling it on a CEX, or vice versa. Decentralized exchange arbitrage is a more specific subset of cross-exchange arbitrage trading. 

2. Intra-Exchange Arbitrage

Unlike cross-exchange arbitrage, intra-exchange arbitrage is contained in one exchange and its different products. There are two major types of intra-exchange arbitrage:

I. Funding Fee Futures/Spot Arbitrage

Most CEXs let you execute futures trades, letting you leverage their positions and bet on the future price of cryptocurrencies. When trading futures, you can opt to go long (if you anticipate a price increase) or short (if you anticipate a price decrease) on a certain asset. 

If there are more people longing than shorting, long traders will pay the funding rate fee to short traders. If there are more people shorting than longing, the opposite is true. 

The concept of funding rate is significant since it allows for funding rate arbitrage. It is a method in which you hedge your futures trade by also taking a position in the spot market. You can enter a futures position that pays you the funding rate while hedging this position with an opposite spot trade. Crypto futures arbitrage nets you a profit equal to the funding rate minus the trading fees. 

II. P2P Arbitrage 

The P2P arbitrage crypto strategy is increasingly mentioned as one of the alternative ways to make money in crypto markets. 

Peer-to-peer (P2P) arbitrage happens in P2P markets, meaning that the transactions are made directly between users. Merchants can post buy or sell advertisements and specify the amount of crypto they are buying or selling, the method of payment, as well as the price they are buying or selling it at. 

The arbitrage part happens when you set the price of the crypto you want to buy or sell in P2P markets. The basic mechanics of crypto P2P arbitrage work like this:

• Find a cryptocurrency with the largest price discrepancy between buyers and sellers. 

• Become a merchant, place both buy and sell advertisements for the said cryptocurrency, and wait for the counterparties to approach you. 

• This will allow you to buy at a lower price and sell the same crypto at a higher price with no added effort. 

However, in order to be profitable from arbitrage in crypto trading on P2P platforms, you will need to ensure the following:

• Take commissions into account: If you are working with a small bankroll, the commissions will most likely absorb most of your profits. Therefore, you should calculate your profitability before engaging in P2P arbitrage. 

• Work with reputable counterparties: Remaining safe is key to staying profitable in a P2P marketplace. Ensure you work with reputable and verified counterparties to reduce the chance of P2P scams. 

• Operate on a secure platform: While your first choice of platform might be based on the price discrepancy between buy and sell offers, you will also need to take into account the platform's security and payment methods. Platforms like KuCoin P2P offer best-in-class security and a dedicated customer support team to help you 24/7 with all your needs. 

While you can perform crypto P2P arbitrage on one exchange, you can also use multiple P2P platforms to boost your gains by finding larger price discrepancies. 

Check out our guide on the 7 benefits of becoming a KuCoin P2P merchant. 

III. Triangular Arbitrage 

A triangle arbitrage strategy may appear intimidating since it requires an expert-level grasp of market pricing inefficiencies and complete knowledge of how to execute transactions to profit from them. 

If you plan to participate in this type of trading, you should have a thorough understanding of crypto and an advanced understanding of arbitrage. 

Triangular arbitrage takes advantage of price discrepancies in the market between three distinct cryptocurrencies. Depending on the price variances, you could employ a variety of techniques to capitalize on these differences. For example, you could place a buy-buy-sell order or a buy-sell-sell order.

Approach 1: BUY — BUY — SELL

1. Buy Bitcoin (BTC) with Tether (USDT)

2. Buy Ethereum (ETH) with Bitcoin (BTC)

3. Sell Ethereum (ETH) for Tether (USDT)

Approach 2: BUY — SELL — SELL

1. Buy Ethereum (ETH) with Tether (USDT)

2. Sell Ethereum (ETH) for Bitcoin (BTC)

3. Sell Bitcoin (BTC) for Tether (USDT)

These deals, like any other sort of arbitrage trading, must be completed quickly. Exchange inefficiencies cause trade execution delays, while market volatility causes price variations before a trade can be executed.

If the triangular arbitrage strategy is too hard to grasp, with a bit of coding knowledge, you can use trading bots, e.g., an arbitrage bot, to do the work for you.

Arbitrage in crypto trading can be a tool of choice for many traders since it offers various upsides, such as:

Quick Profits

The most appealing aspect of crypto arbitrage is that it allows you to make quick and easy money. Because of its quick profit feature, you can easily earn a profit in minutes as long as you act quickly. 

Abundant Supply of Opportunities

New coins and exchanges enter the crypto market daily, benefiting crypto arbitrageurs. There are over 1,500 cryptocurrency exchanges worldwide as of October 2023, with the majority offering slightly different cryptocurrency prices. 

As a result, the rise in crypto adoption and many crypto exchanges provide abundant opportunities for crypto arbitrageurs.

Relatively New Market

The cryptocurrency market is still expanding, and the irregularities are also high due to a lack of shared information among exchanges. Because digital assets have not been universally accepted, there's a limit on the number of exchanges and traders actively participating in the market. 

As a result, the relatively new market has less competition and a high likelihood of profitable price discrepancies.

Crypto Market Volatility

The crypto market experiences high volatility, which could provide several arbitrage opportunities for the same crypto asset across different markets or between different exchanges. 

The huge price differences between exchanges contribute to cryptocurrency's highly volatile nature. This volatility creates more opportunities for crypto arbitrageurs. 

The following factors may make the crypto arbitrage process less appealing to some traders:

You Most Likely Need an Arbitrage Bot

While performing arbitrage manually might be possible, you will often see the price of assets evening out by the time you manage to place trades manually. To fight this disadvantage, you will most likely need an arbitrage trading bot to spot the opportunities based on your input and instantly place trades. 

However, don't be dissuaded by this fact — creating a crypto arbitrage bot is very simple. 

Pay Attention to Fees

Multiple fees are associated with crypto arbitrage, which makes it the first hurdle or hidden barrier. Traders may be charged a variety of fees, including trading fees, withdrawal fees, exchange fees, transfer fees, network fees, and so on. 

The multiple fees involved in crypto arbitrage may impact profitability and, if incorrectly calculated, may result in losses.

Small Profit Margin

New arbitrageurs should know they will require substantial money before beginning or considering crypto arbitrage. 

This is because crypto arbitrage trading usually offers a small profit margin. If you start with small capital, you may lose due to the multiple fees associated with crypto arbitrage trading. 

A large amount of start-up capital is required to make a reasonable profit.

Limited Withdrawal

The majority of cryptocurrency exchanges have set a withdrawal limit. It can also be a detriment or deal-breaker for some traders who want to get into crypto arbitrage trading. 

As previously stated, crypto arbitrage trading has a low profit margin, which means you may not be able to access your profits immediately due to withdrawal limits set by exchanges.

Before entering the market, day traders must conduct technical analysis and use various tools to forecast the future momentum of cryptocurrencies. Furthermore, these trades require time to generate reasonable profits.

On the other hand, traders in the crypto arbitrage market are exempted from this arduous procedure. All they have to do is find the difference between the prices of the same cryptocurrency on two different exchanges. They are not required to analyze market sentiment or perform technical analysis to forecast future price movements. 

If all goes well, the entire process of simple crypto arbitrage takes only a few minutes, making it a faster way to generate income than traditional trading.

Crypto arbitrage is a low-risk gain strategy because it involves lower risk than traditional trading. Predictive analysis can sometimes be incorrect, whereas exchange price differences are legitimate.

The risk exposure automatically decreases because it only takes a few minutes to complete a trade in crypto arbitrage. In traditional trading, the trade is continuously exposed to risk until closed.

Arbitrage opportunities only last a few seconds or minutes. Therefore, it can be challenging for a trader to maximize and calculate all opportunities. This is where trading bots come in. 

Numerous automated bots can access every arbitrage option in the market without stressful and time-consuming calculations.

These automated robots are algorithms and programs that continuously scan multiple exchanges for arbitrage opportunities. This software or robots send notifications to traders, instructing them on how to proceed. Traders can sometimes delegate full authority to these robots, which means that the arbitrage trades are carried out or executed automatically when an opportunity is detected.

Most arbitrageurs use robots or algorithmic programs to optimize their profitability ratio because it speeds up the process by eliminating the need to calculate possibilities.

Learn all about how to use KuCoin's trading bots. 

Undoubtedly, crypto arbitrage trading offers quick profits with lower risk. However, there are numerous factors to consider before capturing arbitrage opportunities. You must conduct extensive research and have large start-up capital to make successful trades.

Crypto arbitrage trade has many advantages, including low risk, little to zero technical analysis, and quick money. However, disadvantages exist, such as multiple transaction fees, a small profit margin, and limited withdrawal. 

Finally, bots can optimize the crypto arbitrage process, but you must choose them only after extensive research. Exercise extreme caution when taking advantage of this low-risk gain strategy to stay safe from potential scammers.