Understanding Crypto - Arbitrage

Very often we are asked why the price of a coin or token is different in different exchanges, but the answer is already in the question itself - those are different exchanges. Each has different rules, different terms and conditions and different types of buyers. Some exchanges have lower fees, so they are filled with people trading constantly, supplying volume and stability. Some are more secure, so have more people holding, leading to bigger price swings and a feeling of an inactive market.

So, the next question that always follows, without skipping a beat - can I buy the coins where they are cheap and sell them where they are expensive. And the answer? Yes, you most certainly can. And many people already do this constantly. It is called “Arbitrage” and is the reason why the price of coins is similar in all exchanges. Now, before you rush off to cash in, you need to consider a few things.

Number of Traders

As we already stated, this is the first thing that comes to mind when people realize that the prices are different. So everyone is informed about arbitrage and has at least looked into it. So there is a good number of traders already doing what you plan to do. Many of them have been doing it for years, devised their own tactics, skill-sets and even computers to do this job for them. While you might be looking for the price difference of 10 dollars, these folk will be ready to trade on the difference of 5 cents. And have already managed to do it in the time it took you to read this sentence.

So there is a possibility that the biggest exchange has no more room for you. At least not in the most well-known coin pairings. At the moment of writing this article, the prices of ETH (Etherium) in four different biggest exchanges are 1,944.48, 1,945.31, 1,946.37 and 1,944.29. While it might seem that there is a difference of 2 dollars, when you look at it as a percentage, it doesn’t mean anything at all. This means that the traders or “arbitrageurs” have actively traded this asset and the price is equalized in most big exchanges. So your safest bet would be a smaller coin in smaller exchanges.

Volatility

Sometimes it happens that a coin is well traded in one exchange, but less in another. A very simplistic way to explain it would be that a huge Chinese exchange would not care about a small, local project in Argentina, but in Argentina it would be the biggest hit. So, for example, there are 2000 traders in an Argentinian exchange but only one in the Chinese exchange. Maybe someone who is from Argentina and knows the project has bought the coins for 20 dollars each.

What we have now is the Argentinian exchange where the previous trade was for 10 dollars, but a Chinese exchange where the previous trade was for 20 dollars. Seems like a no-brainer. A 100% profit. The problem is that the Argentinian exchange has 2000 trades a day, while the last and only trade in the Chinese exchange was 2 months ago. So you buy those coins, run to the Chinese exchange only to find out that no one is willing to buy them. And you discover that you are not the only one - there are already 30 other traders who have made the same mistake that you have and all waiting for the same single buyer. Make no mistake - the Chinese exchange is the biggest in the whole world, just not with this exact coin/asset.

This is, of course, a radical example, but only to portray the problem of demand. When we are talking about the difference of a few cents, minutes matter. You might have to wait a while for your turn to sell and at that point there might not be a difference in the price at all. It could happen that, after paying all the fees, you have actually lost, not gained.

Fees

The most favorite topic of them all - brokerage and transfer fees. Each exchange takes a small percentage from every trade happening. Some take a smaller cut, some take a bigger one, but all of them are important when you plan to do trades with small margins. That 4 cent difference you see could be all lost in commission fees. So you always have to be quick at math and understand each exchange you are working with. And while it might be confusing with two, real arbitrage often consists of more than two trades.

Also, transfer fees. Withdrawing your cash and depositing it in another exchange can not only be a pricey endeavour, but can also take a considerable period of time. Meaning that buying coins in one exchange, transferring them and selling in others is not a smart move. That is why many people do not transfer among exchanges at all.

A very simplified example: You have 100 dollars and a single coin in exchange A and 100 dollars and a single coin in exchange B. Now, in one exchange the price of the coin rises to 102 dollars, in the other it stays the same. You buy the coin in the cheaper exchange and sell in the one where it rose. Now you have 2 coins and 0 dollars in exchange A and 0 coins but 202 dollars in exchange B.

You have not transferred anything between the exchanges, the amount of coins you have is the same, but have gained 2 dollars. Instead of spending money for transfers, you have made a profit. But even this is still a simple approach. It can get way more complicated.

Multiple-way arbitrage

A simple arbitrage of buying and selling the same coin is, more or less, old news. It has gotten more complicated, not just following a single coin, but many coins and their pairings at the same time. Let's say you follow 3 coins at the same time.

For 10 coins A you could buy 5 coins B.
For 5 coins B you could buy 2 coins C.
For 2 coins C you could buy 12 coins A.

If you go through this circle and everything works perfectly, you have just made 12 coins out of 10 coins. And have no doubts - chances like these are rare and are found not by humans, but computers. Basically we have reached into the territory where a human would not be able to calculate all these exchange rates, fees, pairings and such in the few seconds time needed to make the trade. So this is all done already by experts of the field with specific tools.

Conclusion

Still, everyone starts somewhere. Most people using complicated technology started from the basics and then just found the exact area they want to work in and focused on that. So you too should look into various exchanges, get to know their fees and terms, choose your coins that you will follow more closely and see if you can use the price swings to your advantage. Maybe it turns out that it is not for you and you rather just day-trade. Maybe you’ll soon find yourself using complicated tools and explaining to various experts how arbitrage can be improved. One can never know.

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