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Crypto Arbitrage: How It Works & Trading Strategies

By Colin Dodds · August 31, 2022 · 6 minute read

We’re here to help! First and foremost, SoFi Learn strives to be a beneficial resource to you as you navigate your financial journey. Read more We develop content that covers a variety of financial topics. Sometimes, that content may include information about products, features, or services that SoFi does not provide. We aim to break down complicated concepts, loop you in on the latest trends, and keep you up-to-date on the stuff you can use to help get your money right. Read less

Crypto Arbitrage: How It Works & Trading Strategies

What Is Cryptocurrency Arbitrage?

Cryptocurrency arbitrage is a strategy in which investors buy a cryptocurrency on one exchange, and then quickly sell it on another exchange for a higher price.

Cryptocurrencies trade on hundreds of different exchanges, and often the price of a coin or token may differ on one exchange versus another. That’s where the strategy of arbitrage comes in: Similar to using arbitrage in capital markets, crypto arbitrage is a legal way to earn a potential profit when an asset is selling cheaper in one market and at a higher price in another.

That said, crypto arbitrage comes with some potential risk factors. Here’s a closer look at how crypto arbitrage works, and trading strategies that use the tactic.

Why Are Crypto Prices Difference Across Exchanges?

Crypto markets are not regulated, and cryptocurrencies are decentralized and therefore — with the exception of stablecoins — are not pegged to government or fiat currencies like the dollar. This is one of the primary reasons why the prices of different crypto can vary widely: there is no standard price for any particular coin or token.

Related to this, some crypto exchanges are bigger than others, with higher trading volume. Thus the supply and demand on one exchange could be quite different from another, affecting the price.

Finally, crypto trading fees also vary, and can add to the cost of your trades.

What Types of Arbitrage Exist?

There are some different ways investors can conduct crypto arbitrage with different types of cryptocurrencies.

Spatial Arbitrage

Spatial arbitrage involves trading virtual currencies across two different exchange platforms. Spatial arbitrage is a straightforward way of conducting crypto arbitrage.

While this is a simple tactic that can take advantage of price discrepancies, spatial arbitrage exposes the traders to risks like transfer times and costs.

Spatial Arbitrage Without Transferring

Some traders try to avoid the risks of transfer costs and times that spatial arbitrage poses. For example, in a hypothetical case, they may go long Bitcoin on one exchange and short on another, and wait until the prices on the two exchanges converge.

That allows them to avoid transferring coins and tokens from one platform to another. However, trading fees may still apply.

Triangular Arbitrage

Triangular arbitrage takes advantage of pricing inefficiencies among different pairs of cryptocurrencies on the same exchange. With this strategy, an investor starts with one cryptocurrency and then trades it for another cryptocurrency on that same exchange — one which is undervalued relative to the first crypto.

The investor would then trade that second cryptocurrency for a third cryptocurrency which is relatively overvalued when compared with the first. Finally, the investor would trade that third cryptocurrency for the first crypto, completing the circuit potentially a little richer.

How to Take Advantage of Crypto Arbitrage Algorithmically

At first glance, cryptocurrency arbitrage seems like a simple matter of looking for gaps between the prices on one exchange and another, and then executing a buy and a sell.

Famously, in 2017 there was a moment when the price of Bitcoin on Kraken was $17,212, but only $16,979 on Bitstamp — presenting an arbitrage opportunity. In that instance, an investor could potentially make $233 per Bitcoin by buying them on Bitstamp, and then quickly selling them on Kraken.

While spreads aren’t always as wide as in the above example, there are times when other, less well-known forms of crypto could offer even wider gaps. Since cryptocurrency prices can vary from exchange to exchange, arbitrage opportunities can pop up at any time, with thousands of cryptocurrencies trading on hundreds of exchanges for people investing in cryptocurrency.

There are a number of apps investors can download that will track the prices of Bitcoin and other cryptocurrencies for arbitrage opportunities. This way, investors can take advantage of algorithms that automatically scan for arbitrage across different crypto exchanges. This automated approach can allow crypto-arbitrage traders to take advantage of multiple different price discrepancies.

Recommended: How Do Crypto Trading Bots Work?

How to Find a Crypto Arbitrage

Not every cryptocurrency digital asset is created equal when it comes to arbitrage, and there are multiple ways to find arbitrage opportunities.

Method 1: New Software

With so many different cryptocurrencies on so many exchanges, finding those opportunities is a daunting task. That’s why many traders use software applications that track the hundreds of cryptocurrency exchanges in real time.

There are a growing number of companies that specialize in software to automate crypto arbitrage. Some companies have a tool that allows investors to choose an automated arbitrage strategy and execute it across different exchanges.

Method 2: Less Popular Cryptocurrencies

Investors can find bigger price spreads for the same cryptocurrency digital assets among less-popular, less-frequently traded forms of crypto.

Because they’re less popular, though, these cryptocurrencies are prone to rapid price fluctuations. That volatility can be good or bad news, but it adds another level of risk to an arbitrage strategy.

Recommended: Top 30 Cryptocurrencies By Market Cap

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What Are the Dangers of Crypto Arbitrage?

Like any kind of arbitrage, crypto arbitrage involves some potential risks.

Losses

To succeed in crypto arbitrage, investors need to execute the trades quickly in order to take advantage of cryptocurrency price differences from exchange to exchange, while those differences are still profitable.

With the thinly traded forms of crypto that offer the widest spreads, a trader has to be careful not to increase the purchase price and decrease the sale price of a digital asset by their own trades.

Volume

The crypto exchanges all work similarly, pricing crypto based on the last trade on that exchange. But it’s important to note that not all exchanges are created equal. Some of them have enormous trading volumes, while others aren’t as active.

The trading volume on each affects the liquidity and the available prices on a given exchange.

Low volume may mean that the exchange can’t execute a trade large enough to deliver the profit an investor is hoping for. Low volume may also mean that the trade is possible but will take too long to seize the pricing opportunity.

Transaction Costs

At the same time, traders need to keep an eye on the transaction fees that come with purchasing cryptocurrency across trading platforms. As the cryptocurrency markets evolve, these fees continue to fluctuate, varying from exchange to exchange.

Fraud, Hacks

Cryptocurrencies are largely unregulated, which is one of the key things to know before investing in cryptocurrency.

As a result, trading crypto comes with more risks from hacks, fraud, and outright currency collapse. That’s why securely storing your cryptocurrencies is a hot topic among investors.

Taxes

In the U.S., where cryptocurrency adoption has skyrocketed in recent years, the IRS has created a tax guide which categorizes cryptocurrencies as property, like stocks, bonds, and other capital assets.

Recommended: Crypto Tax Guide 2022: How to Report Crypto on Your Taxes

Investors are required to pay capital gain taxes on cryptocurrency when selling, trading, or disposing of their holdings. Additionally, cryptocurrencies can be taxed as income if an individual receives the crypto as a gift, from mining, or for services rendered.

With that in mind, investors must account for any capital gains taxes on their federal income tax return, but may also be able to take deductions based on any losses.

Though the IRS treats cryptocurrencies as property for tax purposes, this categorization is not consistent across all federal government agencies. The question as to whether crypto is a security or a commodity is a long-standing debate. The Securities and Exchange Commission (SEC), has called cryptocurrencies a form of security — and the Commodity Futures Trading Commission has called them a type of commodity.

As of August 27, 2022, different bills have been proposed in Congress to make the regulation of cryptocurrencies consistent.

The Takeaway

Arbitrage exists across the capital markets, in stocks, bonds, and commodities, wherever the same asset trades for different prices in different places. Since cryptocurrencies are digital and aren’t based on an underlying asset, it is harder to place a value upon these currencies, and they don’t have the same pricing conventions as equities and bonds, which are tied to the performance of a company, municipality, or nation.

Cryptocurrency is complicated, and arbitrage strategies can be even more complex. But the practice is legal, and has the potential to yield high rewards while also exposing an investor to high risk.

As with any investment strategy, it is important for investors to do their own research when exploring crypto arbitrage, including looking at different, lesser-known cryptocurrencies, and available software to track cryptocurrency exchanges in real time.

To become more familiar with the crypto markets, it helps to start with a secure platform like SoFi Invest, where you can open an Active Invest account easily and start trading crypto with as little as $10. SoFi doesn’t offer staking or a crypto wallet, but you can trade dozens of crypto 24/7. Plus, SoFi takes security seriously and uses a number of tools to keep investors’ crypto holdings secure.

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SoFi Invest®
The information provided is not meant to provide investment or financial advice. Investment decisions should be based on an individual’s specific financial needs, goals and risk profile. SoFi can’t guarantee future financial performance. Advisory services offered through SoFi Wealth, LLC. SoFi Securities, LLC, member FINRA / SIPC . SoFi Invest refers to the three investment and trading platforms operated by Social Finance, Inc. and its affiliates (described below). Individual customer accounts may be subject to the terms applicable to one or more of the platforms below.
1) Automated Investing—The Automated Investing platform is owned by SoFi Wealth LLC, an SEC Registered Investment Advisor (“Sofi Wealth“). Brokerage services are provided to SoFi Wealth LLC by SoFi Securities LLC, an affiliated SEC registered broker dealer and member FINRA/SIPC, (“Sofi Securities).
2) Active Investing—The Active Investing platform is owned by SoFi Securities LLC. Clearing and custody of all securities are provided by APEX Clearing Corporation.
3) Cryptocurrency is offered by SoFi Digital Assets, LLC, a FinCEN registered Money Service Business.
For additional disclosures related to the SoFi Invest platforms described above, including state licensure of Sofi Digital Assets, LLC, please visit www.sofi.com/legal.Neither the Investment Advisor Representatives of SoFi Wealth, nor the Registered Representatives of SoFi Securities are compensated for the sale of any product or service sold through any SoFi Invest platform. Information related to lending products contained herein should not be construed as an offer or prequalification for any loan product offered by SoFi Bank, N.A., or SoFi Lending Corp.
Crypto: Bitcoin and other cryptocurrencies aren’t endorsed or guaranteed by any government, are volatile, and involve a high degree of risk. Consumer protection and securities laws don’t regulate cryptocurrencies to the same degree as traditional brokerage and investment products. Research and knowledge are essential prerequisites before engaging with any cryptocurrency. US regulators, including FINRA , the SEC , and the CFPB , have issued public advisories concerning digital asset risk. Cryptocurrency purchases should not be made with funds drawn from financial products including student loans, personal loans, mortgage refinancing, savings, retirement funds or traditional investments. Limitations apply to trading certain crypto assets and may not be available to residents of all states.
22Terms and conditions apply. Earn a bonus (as described below) when you open a new SoFi Digital Assets LLC account and buy at least $50 worth of any cryptocurrency within 7 days. The offer only applies to new crypto accounts, is limited to one per person, and expires on December 31, 2022. Once conditions are met and the account is opened, you will receive your bonus within 7 days. SoFi reserves the right to change or terminate the offer at any time without notice.

First Trade AmountBonus Payout
LowHigh
$50$99.99$10
$100$499.99$15
$500$4,999.99$50
$5,000+$100

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