Hedge Funds Game: Crypto Arbitrage Trading

Jeremy Stone Crypto Arbitrage Read 5min

Cryptocurrencies, like the very popular and largest blockchain network Bitcoin, followed by Ripple, Ethereum and Tether, have different exchange rates which can be quite substantial. This provides a very good platform for arbitrage traders to jump in and cash the large price differences.

Arbitrage Trading:

Arbitrage means buying and selling simultaneously of currency, security, or commodities in the different market as to take advantage of different exchange rates in those markets and generate a profit from that.

For example, if a person A buys a security asset of $200 in one exchange X, while simultaneously sells that assets on an exchange Y where the price of that asset is $195 at the same time, making a risk free profit of $5. This is Arbitrage trading.

The Market is kept relatively efficient because of these opportunities for arbitrage trading. Because this trading ensures that the prices across different exchange markets are more or less the same for the asset, if that is not the case, then, the arbitrage traders will come and capture the profit opportunities immediately.

In the stock market, this arbitrage trading is usually done, on behalf of the investor, through high-frequency software that digs out these arbitrage opportunities, and executes the trades for the investor. The property trading companies such as Hedge funds are the most common investors who seek out and make use of these algorithmic opportunities in the stock exchange market.

Arbitrage with Cryptocurrencies:

As mentioned previously, the differences in price for the cryptocurrencies across different markets can be quite astonishing, making ample opportunities for making arbitrage profits.  Not only that, but the price differentials also exist within the same country and can be easily utilized without having to go for the extra risk of trading foreign.

Price variation in Cryptocurrency is due to the difference in liquidity, meaning that there is a lack of International price reference standards and nonefficient fund transfer between different exchange markets. The prices might be higher on some exchanges because it is expensive to withdraw fiat for that exchange, thus increasing the demand for crypto as it provides a cheaper vehicle to move your money from the exchange.

Main Crypto arbitragers:

A large amount of investment is required to be able to profit from arbitrage trading. The two main parties in the arbitrage crypto world are the hedge funds and the “whales”.

Whales are the very early who adopted the cryptocurrency trading and now have millions in terms of the crypto. They can place big trade so they can make a profit from a difference of $50 in bitcoin. Due to there experience, they are very much familiar with the arbitrage trading strategies and can easily navigate through the markets and exploit the necessary liquidity.

The other, Hedge funds have the resources and capital to execute a strategy and over 225 funds regarding this field to utilize their approach as a part of the investment strategy.

Whether to do Arbitrage trading or not?

Well, this is a very tough question. You see, since you are going to start as a small investor, and taking in account the cryptocurrency exchange rate, t is going to be hard to be able to engage yourself because, in cryptocurrency markets, as you need a large amount of investment in order to generate decent enough profitable revenue. If you plan to start crypto arbitrage with a small investment of thousands of dollars, then, accounting in the trading and withdrawal fees, the profit margin will easily overtake you. For it to be profitable, a bare minimum of $100,000 is required, even so, the profit after that is also quite small.

This Crypto Arbitrage market seems very easy to execute, exploit and utilize but it has its own challenges.

  1. For you to generate a profit, you need to buy and sell simultaneously, in bulk volume in order to benefit from the small price difference. Bitcoin might be growing in daily trading, but it still has a very small asset class when compared to others like bonds and stocks, which translates of it having a very light Liquidity. If you buy and sell BTC of 10,000, then it will be hard to find an exchange in which orders of a size like this can filled easily for the trade to profitable, hence making it harder. Liquidity becomes more of an issue when done with altcoins, which have low trading volumes and market capitalization.
  2. Transferring of fund between the exchanges in order to take advantage of the arbitrage opportunity is necessary. But some times it takes too long, and the opportunity to arbitrage might slip during that wait.
  3. The transaction fee, which although is small but it adds up when the funds are constantly moving between the market. Then there is a trading fee, which is approximately between 0.1-0.3% for each major exchange trade. Then this is to multiply to two for arbitrage as it is from two sides. There are few zero fee exchanges, but most exchanges you will trade on the market are charged. Thirdly, the Exchange fee, which is required since you are transferring funds between the exchanges and lastly in your wallet. They are usually small, but if you are constantly rotating funds between exchanges and back to your wallet, they will add up similar to the other two fees and very likely make your profit margin to go into negative.
  4. In order for you to avail the hard-earned profit, you need to take the digital profit off the exchanges and then cash out into your fiat currency. Depending upon the exchanges used and payment method, it can cost you a few extra.

Considering these points, it is therefore advised for you to find opportunities that provide a trading profit of at least 2 or more percent as anything less can easily be turned back to negative by the fees that have been cost to make the trades.

The Risks:

While the risks in crypto arbitrage trading are considered to be nearly free, but it, in reality, is not a total risk-free strategy. There are always risk of loses from holding large amounts of cryptocurrency in central exchange as a clever strategy to make more profit, but then suddenly you end up losing your money.

The centralized digital exchange is possible to be subject to operational errors and cybersecurity breaches. Laws do not regulate the cryptocurrency in most parts of the world. Therefore, there are little legal resources for the people who lose their digital funds via cybercrime. And only a few exchanges offer insurance for their clients funds against the unexpected loses.

This all translates for this trade to have a potential risk of losing your funds which you have deposited on the exchanges because, if you want to execute the arbitrage strategies efficiently, then you need to have funds sitting on several different exchanges at the same time. So in order to minimize these risk, you need to withdraw your digital and fiat currency when you have finished your exchange for the day, but as previously mentioned this further increases the fees.

For you to even generate a small profit, investors are required to put large amounts of funds at exchanges. Therefore the loss of held funds on the centralized exchange needs to be considered and matched with the earned profits that you have made.

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If you want to minimize the losses mentioned above then you need to adopt Arbinox.

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