Category List
Crypto Arbitrage Explained: Strategies, Bots, and How to Profit from Market Inefficiencies
In cryptocurrency trading, multiple strategies exploit inefficiencies in the market. For example, divergence strategies seize price differences between indicators and asset price movements. Other methods to approach such discrepancies result in arbitrage opportunities, and implementing bots can be the best way to profit from those situations.
Altrady's team has found that exploiting signals can be an outstanding procedure for implementing an arbitrage strategy. But what is arbitrage trading, and which types of arbitrage strategies and bots exist? This guide offers an understanding of those questions.
Understanding Crypto Arbitrage Trading Strategy
The concept of market inefficiencies plays a central role in grasping arbitrage trading possibilities. It revolves around emerging discrepancies in the price of diverse asset pairs, markets, and exchanges. When a specific asset experiences temporary price disparities between two or more exchanges, it derives in a market inefficiency, leading to arbitrage trading opportunities.
Since exchanges act as market providers, essentially central custodians responsible for processing trades, they deal with crucial transactional issues. They have to be able to provide the required infrastructure to handle two significant factors causing the price movements in the market:
- Varying liquidity: This occurs given the decentralized nature of cryptocurrencies. Insufficient liquidity impacts the speed of order execution, provoking partial filling, volatility, and slippage.
- Inconsistent trading volume: Due to lower institutional participation, poor market maturity, high-grade leverage, broader bid-ask spreads, etc.
Which crypto assets are more exposed to arbitrage?
To a large extent, market inefficiencies arise following transient liquidity problems amid volatility seasons. Especially across mid-cap and low-cap assets or between crypto pairs, for example:
- XRP/ADA
- ADA/ETH
- DOGE/ADA
What is an arbitrage strategy?
In essence, crypto arbitrage trading implies buying a determined digital asset pair in exchange A and selling it in exchange B, or the same exchange, in any case, seizing a notable difference from a lower to a higher market price. Consequently, the trader profits from an increase in the holding of the underlying asset.
Types of Arbitrage Strategies
As implicitly noted above, implementing arbitrage trading is possible between two or in the same exchange. Moreover, this technique can involve further sophistication through algorithms and statistics. Let's overview each type.
Inter-Exchange Arbitrage
The most straightforward yet effective. This method seizes substantial price discrepancies among different exchanges. It has proven to yield great results by consistently buying a crypto coin in one exchange and selling it later in another at a higher price.
Intra-Exchange Arbitrage
This approach consists of a more composite process operating a single exchange. Given that it requires three pairs of cryptocurrencies, it is known as Triangular Arbitrage.
Let's break down a (fictitious) example using the pairs noted in the first section:
- ADA can buy XRP for a value of 0.5 ETH per XRP.
- ETH can buy XRP for a value of 0.6 ADA per XRP.
- ETH can buy ADA for a value of 1.8 XRP per ADA.
So, the logic would be:
- Start with ADA buying XRP at the rate of 0.5 ETH per XRP.
- Use the acquired XRP to buy ETH at a rate of 0.6 ADA per XRP.
- Use ETH to buy back ADA at a rate of 1.8 XRP per ADA.
If we start with 1 ADA:
- 1 ADA will buy 2 XRP (1/0.5=2)
- 2 XRP will buy 1.2 ETH (2*0.6=1.2)
- 1.2 ETH will buy 2.16 ADA (1.2*1.8=2.16)
Therefore, the arbitrage increases the ADA balance.
Statistical Arbitrage
By relying on statistics, quant models and algorithms, this type performs arbitrage strategies at a high degree of execution. Statistical models will exploit price discrepancies often overlooked by human capacities.
Decentralized Arbitrage
Given the nature of cryptocurrencies, this market splits between centralized exchanges (CEX) and decentralized exchanges (DEX). Traders or algorithms can identify price differences across exchange types, often taking advantage of lower fees.
Arbitrage Bots and Crypto Platforms: How Do They Work?
Traders can use bots for every arbitrage strategy described above, achieving high performance through automation. Let's overview some platforms to achieve such a procedure.
Arbitrage with a Signal Bot
A Signal Bot like the one offered by Altrady, a multi-exchange platform, can use the pine script of Tradingview to automate execution when price signals emerge. By using both platforms, traders can employ the following process:
- Tradingview: Calculate the price difference (spread) between two or more assets traded on different exchanges. For instance, you could compare the price of BTC/USDT on Binance and Kraken. Then, set thresholds for the spread, and the pine script will generate alerts when the spread exceeds those thresholds.
- Altrady: Pine Script generates alerts when the spread hits a determined price but can not trigger trades. However, the signal bot does. By connecting it to Tradingview, Altrady automatically executes trades based on the alerts.
You can learn how to do it with the official documentation: Signals and Automation | Altrady
AI Bot Arbitrage
Statistical arbitrage can use an AI bot like the one featured by Wundertrading. This bot employs historical data to execute complex strategies based on price disparities in the market. This bot relies on a mean reversion strategy to exploit price spreads. You can learn more about it here.
Triangular Arbitrage
CryptoHopper lets traders customize bots for multiple strategies. In this case, you could adapt a bot to perform triangular arbitrage, as this doc explains.
Key Aspects of Arbitrage Bots
- Automated trading: As described, automated execution can accomplished through signals, AI models, and customization.
- Considerable low risk: Identifying price discrepancies may be easier than predicting the market. In this sense, this method involves lower risks. Nevertheless, it still carries some pitfalls.
Common Pitfalls and Challenges of Arbitrage Trading
- Liquidity and volatility: Insufficient liquidity and volume can impact the price movements, hence the profit potential of crypto arbitrage trading.
- Timing delays and fees: Transferring funds may take time, especially when using on-chain transactions where blockchain networks can experience congestion. Also, fees may impact profits.
Conclusion
Cryptocurrency markets offer a wide range of opportunities where arbitrage trading stands out due to the nature of this market. Approaching all the potential cases for arbitrage requires speed, and one way to reach high performance is by implementing bots.
Altrady stands out as a multi-exchange platform with automation capabilities. The signal bot can execute trades based on multiple alerts from third-party providers like Tradingview. Trying it is as easy as seizing a free trial account with backtesting and paper trading features.
