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What is Arbitrage Trading?

The Beginner’s Guide to Arbitrage


Ever wondered why the price of bitcoin differs from exchange to exchange? 

This may seem unusual at first, but it’s quite common for any asset that trades on an open, global market. For example, when Bitcoin rose to all-time highs in 2017, data shows $19,600 was the highest price paid for the cryptocurrency on Kraken. 

Other exchanges show different price highs, reflective of the trading history of their users, with some recording prices as high as $20,093. 

Savvy traders, known as arbitrage traders, know how to take advantage of these small price discrepancies, and they can turn a potential profit from buying and selling the same asset on different markets.

In traditional finance, arbitrage opportunities exist for securities, commodities and currencies traded on different global markets. (The price of a stock may differ between the New York Stock Exchange, the Tokyo Stock Exchange and the Bombay Stock Exchange.)

In cryptocurrency, traders find arbitrage opportunities by purchasing and selling crypto assets across different exchanges, allowing them to capitalize on different prices for the same asset.

If we take the December 2017 all-time high as an arbitrage example, bitcoin arbitrage traders could have bought 1 BTC at Kraken, transferred it to another exchange with a different price to sell, and could have turned a potential profit based on the price variance, minus fees.

Of note, those who wish to participate in arbitrage trading should tread lightly: transaction costs and exchange fees can negate the gains made from these trades.
 

what is arbitrage trading


Crypto Arbitrage and the Law

Since arbitrage seems like a simple way to turn a potential profit, it is fair to ask yourself: is arbitrage legal? In most countries around the world, arbitrage trading is perfectly legal as it contributes to market efficiency. 

Once a crypto arbitrage trader has completed their trade, they will inevitably bring additional traders to the market who are hoping to exploit the same price difference, which will eventually lead to the asset’s price to become more balanced across markets.

However, there are exceptions. You should read up on your local laws before participating in cryptocurrency or bitcoin arbitrage trading. 

When in doubt, always consult a local lawyer or accountant before proceeding.
 

What is Crypto Arbitrage?


With Bitcoin’s high fees and often slow transfer times, bitcoin arbitrage traders have pivoted to more efficient options across cryptocurrency markets. 

Kraken, for example, offers over 150 trading pairs, so, depending on the price of crypto assets across different markets, crypto arbitrage traders can exchange certain cryptocurrencies for others, or for more stable fiat currencies. 

Through a single exchange like Kraken, you can participate in triangular arbitrage trading, which involves spotting the price differences between three cryptocurrencies on the exchange. For example, you can purchase XLM with BTC, sell XLM to ETH, and convert ETH back to BTC.

Arbitrage in Decentralized Finance

The rise of decentralized finance (DeFi) has brought about the creation of decentralized exchanges, such as Uniswap, Balancer and Curve, a type of exchange operated by a global network of computers rather than a central operator. 

Most decentralized exchanges, rather than maintaining a central order book where buyers and sellers can place orders, use a collection of liquidity pools, where the crypto asset price is dependent on those who provide liquidity to the pools. 

When used in conjunction with a crypto exchange like Kraken, traders are able to spot arbitrage opportunities in pools that experience a price slippage due to large transactions.

Arbitrage Considerations

If it is your first foray into arbitrage trading, there are a few things you may need to take into consideration: 

  • Fees – It is important to consider fees in your trading equation, as they can negate any potential profits. For example, fees on Kraken range from 0.1% to 0.26%, so, you may want to avoid arbitrage differences lower than 0.30%.
  • Volume – The higher the trading volume on a cryptocurrency, the higher the liquidity of that coin, which increases the probability of your trades being executed. 
  • Avoiding Slippage – Price slippage occurs when you get a different price than expected on an entry or exit from a trade. Thus, extensive research and perfect timing of the market becomes a crucial component of arbitrage trading.

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Useful Resources

Looking to learn what decentralized exchanges may help you find different cryptocurrency arbitrage opportunities? Head on over to Kraken’s Learn Center for a deeper dive into protocols like Kyber Network, Uniswap or SushiSwap

If you are interested in learning more about the different cryptocurrencies, you can visit Kraken’s “Types of Cryptocurrencies” page. 

Finally, if you want to spot additional opportunities, you can bookmark Kraken’s price page, which allows you to follow the state of the cryptocurrency market.