Till a year ago, crypto prices were skyrocketing, and Bitcoin was trading at $20,000. A year down the line and the crypto market is in a constant state of decline. However, the good news is that cryptocurrency arbitrage offers an easy way to earn money despite the testing times that we see today. In this article, we shall present a step-by-step guide to making money on arbitrage with cryptocurrencies.
What is Arbitrage?
It is the simultaneous sale and purchase of assets to profits from imbalances in their prices. It is a kind of trade that gains by leveraging the differences in the rates of identical or similar financial instruments in different markets. Here is a step-by-step guide to help you earn money on arbitrage with cryptocurrencies.
- Find opportunities within the exchange or between exchanges to earn money.
- Decide whether you want to buy or not by doing the following-
- Estimating the wallet fees required for the transaction.
- Accounting for the risks like time required for transaction and market volatility.
- Estimating the amount of taxes.
Finding Opportunities for Arbitrage
There is an opportunity for arbitrage when you can buy something instantaneously for a low price and sell it for a higher price. There are mainly two types of cryptocurrency arbitrage, i.e., arbitrage within an exchange and arbitrage between exchanges.
Arbitrage Between Exchanges
This is the most common type of arbitrage because it has a lot of similarities to sports arbitrage or fiat currency arbitrage. The idea is to benefit from the price differences that exist for the same coin on different exchanges. You can do so by registering on multiple exchanges of your choice. You should deposit fiat one of these exchanges and purchase a cryptocurrency. You can later transfer this cryptocurrency to another exchange, sell it, and withdraw the profit.
Arbitrage Within An Exchange
Altcoin arbitrage within an exchange is almost the same as triangular arbitrage or cross-currency arbitrage. You can begin by registering and depositing some amount of fiat on an exchange. You can purchase cryptocurrency A and later sell it to buy cryptocurrency B. You can repeat this and eventually sell cryptocurrency B for fiat. You can also substitute fiat with another crypto and repeat the procedure multiple times with different cryptocurrencies. Ultimately, it won’t remain a triangular arbitrage but become a polygonal arbitrage.
If you have finally identified an arbitrage opportunity and know the profit that you will make, it’s time to figure in the fees that you will have to pay. There are three main sources of fees at exchanges. The first fee will be levied on the deposit or withdrawal of fiat. The second fee is the transaction fee, the rate of which depends on the exchange that you have chosen. The third fee is charged for the deposit and withdrawal of cryptocurrency.
Minimizing the Fees
You can use the following tricks to minimize the fee required for cryptocurrency arbitrage trading.
- Match your transaction to ensure the immediate execution of your order.
- Use exchanges that charge little to no fee for crypto withdrawal.
- Use wire transfer instead of a direct deposit or credit card.
- Use exchanges that have a deposit account.
Cryptocurrency arbitrage is full of risks. Some of the most prominent ones have been mentioned below.
Hacking risk: Hacking risks have accounted for millions of stolen Bitcoins. You can mitigate this by spreading your funds across various exchanges. Also, keep the amount that is indispensable to your needs in the cold storage.
Execution risk: This happens because of market volatility or a fast-moving market. You must perform at least two transactions, which should be immediately executed. However, the fast-moving prices might result in your order getting stuck at the exchange, and you might also have to pay a taker fee. You can mitigate this risk by using a bot that trades for you.
Movement risks: Most exchanges require a few days to validate the deposit and withdrawal. This would also include issues of wallet maintenance and a down network. To mitigate this issue, you can use well-known exchanges with large trading volumes.
Price decline risks: The trading funds will decline with a higher percentage than profit from arbitrage. You can use margin trading to deal with this issue, but that would cost you more.
It is natural to forget that you need to calculate taxes on your crypto assets once a year, in the adrenaline rush of investment and trading. Crypto taxation is a complex subject as the tax laws vary from one country to another. The tax laws also differ for an individual and a legal entity. Taxation can be as simple and straightforward as in the Netherlands, where authorities consider cryptocurrencies as a capital. Therefore, taxes are only calculated on cryptocurrencies once a year on a fixed date, i.e 1st January. On the contrary, in the US, where cryptocurrencies are considered assets, taxes have to be paid on every transaction.
Finding the right arbitrage opportunity and figuring in the fees, taxes, and risks are the most critical things in cryptocurrency arbitrage. I believe that you would need several arbitrage transactions to cover your deposit, withdrawal fees, and taxes. If you take all these factors into account, your chances of succeeding at crypto arbitrage increase manifold.