For people interested in using cryptocurrencies as an investment strategy, there are multiple perspectives to consider. Some people may choose a passive, long-term approach. Other people may prefer a more active strategy of cryptocurrency arbitrage. These strategies will of course vary based on one’s goals and resources.
Making the Case for Cryptocurrency Arbitrage
According to Investopedia, ”Arbitrage is the simultaneous purchase and sale of an asset to profit from a difference in the price.” This is made possible due to inefficiencies within the market. Odds are, if you have tried to track the price of cryptocurrencies, you have found that different markets report different prices. These differences are usually small, but exist nonetheless.
For example, you may find that Bitcoin is trading for $2685 on Bitcoin, but the last price of Bitcoin is only $2611 on Kraken. How is this possible? Once again, it relates to inefficiencies within the market. If there were only one cryptocurrency exchange, we might not see this type of discrepancy. However, each unique cryptocurrency exchange consists of its own population of buyers and sellers that dictate the price for each coin.
If you have been following cryptocurrency for even a short period of time, you have seen how volatile the market can be. This is true for individual coins and the market as a whole. This volatility helps to create the opportunity for cryptocurrency arbitrage. Because the price of cryptocurrencies can fluctuate substantially over short periods of time, this only reinforces the margins of profit that can be made.
Cryptocurrency Arbitrage Isn’t Right for Everyone
By definition, arbitrage typically involves the buy and selling of a security over a short period of time. For this strategy to work, you must be prepared to buy and sell cryptocurrency at any given moment. The cryptocurrency market does not have an open or close time. There is always cryptocurrency trading going on around the world.
For individuals who have limited time to devote to cryptocurrency trading, cryptocurrency arbitrage is likely too involved to be the correct answer. The simplest strategy is to invest in a diversified portfolio and hold on to those coins for an extended period (whether that be seen as weeks, months, or years). As the cryptocurrency market matures, many of the top performers will continue to see their value rise.
It’s also difficult to take advantage of cryptocurrency arbitrage without a large principal to invest. Remember, with this strategy, money is made on the margin between markets – this is only indirectly related to the price of the coin itself.
Let’s look at a very generic example. Let’s say our random cryptocurrency trades for $1.00 on “Exchange A” and trades for $1.06 on “Exchange B.” If you spent $100 at Exchange A and transferred them to Exchange B, you could immediately sell them for $106 – a quick profit of $6. Congratulations, you have just earned yourself a free lunch at a fast food restaurant. At $6 profit per transaction, you will need to make dozens or hundreds of transactions each day to make a living (which is going to be very difficult without a very well-developed cryptocurrency arbitrage bot).
On the other hand, let’s look at a trade who can invest $100,000 in this cryptocurrency arbitrage. They buy 100,000 coins on Exchange A and immediately sell them back off for $106,000 on Exchange B – a $6,000 profit.
Both transactions take place in the same market conditions and require the same amount of time on behalf of the trader (although most likely, a cryptocurrency arbitrage bot is being used here). However, let’s take a look at the profits: $6 vs. $6,000!
One Last Word of Caution
So let’s say the first two conditions for cryptocurrency arbitrage don’t provide any stumbling blocks for you. You are committed to day trading cryptocurrency. You have a large amount of money to invest in this effort. What’s one last area that may significantly impact your ability to make money with cryptocurrency?
The answer is transaction fees. Many cryptocurrency exchanges and cryptocurrency marketplaces charge a small percentage fee for completing each transaction. This fee varies depending on the exchange.
However, it is critical that you consider these costs before completing any transactions. If you fail to factor in these transactions fees, one of two things will happen: you will either make a substantially smaller profit than you originally projected, or worse yet, you may actually end up losing money on each deal that you make.
Using the arbitrage to make money with cryptocurrencies like Bitcoin, Ethereum, and LiteCoin can be a difficult task. As explained above, it’s not right for everybody. However, under the right circumstances, it might just be an investment gold mine for you!