What is crypto arbitrage?
The act of making money through crypto arbitrage involves simply buying coins at a lower price in one place and selling them at higher prices in another place, often as quickly as possible. An (unrealistic but clear) example:
Coinbase is buying/selling ETH for $2,500/token
Binance is buying/selling ETH for $2,550/token
You take $1 million and buy 400 ETH tokens on Coinbase, transfer those tokens to your ETH wallet on Binance, and sell those 400 tokens for $1,020,000- an instantaneous $20,000 profit.
Throngs of finance institutions are doing this and have done this with stock markets throughout history. If you can truly find arbitrage opportunities, it is a very low-risk way to make some money. It does, however, require you to have a fair amount of money to play with in order to make sizable returns. The largest differences in prices on exchanges tend to happen when the crypto market is volatile- which happens quite a bit. The opportunities are more or less independent of whether the market is moving up or down.
Can I make money through cryptocurrency arbitration?
In general, unless you have access to fee-free trading, trying to make money through cryptocurrency arbitrage is very difficult- you’d be much better off just increasing your investment amount when the crypto market has a big correction, and selling that crypto in increments as the price comes back up. Exchanges like Coinbase and Binance charge 2%+ fees on all of their sell orders- and what’s worse, the exchanges usually give you a price that’s less when you sell and more when you buy of what the “real” price of that crypto is. This same effect (the “bid-ask spread”) takes place with brokerage accounts for stock market trading, but to a much lesser extent. There’s a reason why Coinbase is posting record profits.
Sentiments, legality, and other factors can be very different with different geographies- let’s say Elon Musk tweets that Bitcoin is bad for the environment- Bitcoin prices will fall in the US, but not necessarily quite so quickly on other exchanges across the world. A savvy Japanese investor swoops in and buys some crypto on an American exchange, then sells it back on a Japanese exchange for a 5% profit (just an example). The trouble with this is that (depending on the country) these traders might run into anti-money laundering laws or other regulatory issues.
Differences in fiat currencies
It’s assumed that most investors will want to cash out the fruits of their arbitrage trades in fiat- but if they purchased coins in a different currency (US Dollars) than what they sold them in (Japanese Yen) there’s also price movements that have been happening between the Yen and Dollar. As a matter of fact, many investors make their living through fiat currency arbitrage. These dynamics of fiat currencies and cryptocurrencies can make the cross-border arbitrage trading very complicated.
The more you trade, the more you lose and pay in fees
Warren Buffett famously said in one of his letters to Berkshire Hathaway shareholders that the “4th law of motion” after Sir Isaac Newton: “For investors as a whole, returns decrease as motion increases.” The more transactions you make on exchanges, the more trades you make, the more you move money around, your returns will decrease. This happens for two reasons. First, there are the fees that the middlemen (the crypto exchanges in this case) charge you for your trades. The second reason is that 90%+ of day-traders end up getting returns less than diversified buy-and-hold investors. In my early experience with crypto, I was definitely guilty of day trading- but I soon realized that my “research” wasn’t actually doing anything, and I was just chasing the dopamine hits I would get when prices increased (i.e. gambling).
The efficient market hypothesis & crypto arbitrage
It sounds fancy, but all the efficient market hypothesis says is that prices are exactly where they should be given all available information and that market inefficiencies do not exist. What are market inefficiencies? They happen when the “true” value of something is not reflected in its current price. Let’s say you find a used Subaru an owner is selling in your neighborhood for $10,000- but once you check the stats on Kelley Blue Book it says the car “should” be worth $15,000. That’s a $5,000 inefficiency- go buy the car and sell it to someone else for $15,000! Just kidding, I think cars are liabilities and poor investments with few exceptions.We know the efficient market hypothesis probably isn’t true in the stock market- how are hedge funds making so much money? Not all information is available and thus prices aren’t necessarily true reflections of value. Cryptocurrency (even with its current $2T market cap) is grossly undervalued given how potent the technology is.
Stick to the fundamentals
Unless you’re a highly experienced crypto trader (5+ years of trading experience), it’d be wise to stay away from the arbitrage game for the reasons listed above. My recommended strategy for cryptocurrency is and will be to keep a diversified portfolio of a mix of the top 10 cryptos- with more weight toward the very top (Bitcoin, ETH, ADA). And then hold that for as long as possible, while taking profits in small increments as the prices of those cryptos rise.