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Cryptocurrency arbitrage trading is gaining more and more among investors, especially new investors who, for the most part, want to carry out high-frequency trades, but with low risks.
In this trading strategy, investors capitalize on small price differences of a digital asset within the exchange market. Thus, it is possible to buy an asset on a given exchange and sell it on another with the highest value, almost simultaneously.
This process allows the investor to obtain profits with an extremely low or even zero risk percentage.
Understanding Cryptocurrency Arbitrage Trading
Anyone who thinks that arbitrage negotiations emerged in the crypto market is wrong, this strategy has been one of the pillars of traditional financial markets, but it is a fact that there is great potential for opportunities for this strategy within the cryptocurrency scenario.
Many of these opportunities are related to the volatility present in cryptocurrencies compared to other financial markets. Due to the high variation in cryptocurrency prices, it becomes easier to find discrepancies between exchanges.
In this way, all that is needed is to identify any difference in the price of a digital asset between two or more exchanges and execute a series of transactions, taking advantage of the difference to make a profit.
However, a question must be asked, why is there this difference in values between exchanges? To understand this variation in pricing, it is necessary to understand that there are two types of exchanges in the market.
The pricing of assets on centralized exchanges directly depends on the most recent buy and sell order in the exchange’s order book, i.e. the most recent price at which an asset was bought or sold is considered the real-time price of that asset on the exchange.
Therefore, asset values within exchanges are an ongoing job of staking out the market price based on their most recent sale price. The value of the asset may also fluctuate due to investor demand, which may vary on each exchange.
Decentralized crypto exchanges use a different pricing method than centralized exchanges. This method is known as an “automated market maker”, in which it relies directly on cryptocurrency arbitrage investors to keep values in line with that of other exchanges.
In place of the order book, decentralized exchanges use a liquidity pool, for each cryptocurrency trading pair a pool must be created.
The pools are funded by voluntary contributors, who deposit their crypto assets to provide liquidity, in exchange they receive a proportionate share of the pool’s transaction fees.
The great advantage of this system is that investors do not need to wait for a counterparty to buy or sell the assets at a certain time, trading can be carried out at any time.
Type of Cryptocurrency Arbitrage Strategies
There are a few ways to make a profit through cryptocurrency arbitrage, let’s understand a little more about them.
Arbitrage Between Exchanges: This is the simplest and most popular method of arbitrage trading, it is enough for the investor to buy digital assets on one exchange and sell them on another for a higher price.
Spatial Arbitrage: This type of trading is the same as inter-exchange arbitrage, the only difference is that the exchanges are located in different regions.
Triangular Arbitrage: In this method, the investor must move funds between three or more digital assets on a single exchange, so it is possible to capitalize on the price discrepancy of one or two cryptocurrencies.
Decentralized Arbitrage: This process is common in decentralized exchanges, the prices of cryptocurrency trading pairs are discovered with the help of automated and decentralized programs, the smart contracts. In case the prices between cryptocurrency trading pairs are different from their spot prices on exchanges, it is possible to trade between exchanges.
Statistical Arbitrage: This method combines economic, statistical and computational techniques to execute arbitrage trades at scale. In this process it is common to use bots.
Why is cryptocurrency arbitrage considered a low-risk strategy?
The big difference in using cryptocurrency arbitrage trading is that it is not necessary to predict the future values of cryptocurrencies, nor to enter into negotiations that can take hours or two to generate a profit.
Trading is based on the expectation of generating a fixed profit without necessarily analyzing all the data present in the market, speculation or other pricing strategies.
Another point is that depending on the resources used, it is possible to carry out arbitrage trades in seconds.
However, this does not mean that this type of trading is completely risk-free, it is necessary to be aware of all points to prevent profits from being minimized.