Updated: Jun 30, 2022
In Part 1 of our Crypto Arbitrage for Beginners guide, we talked about the basics of arbitrage trading and its pros and cons. In the same article, we talked about how arbitrage trading is a low-risk investment strategy that offers quick rewards.
But to find substantive success in the arbitrage scene at minimal risk, you need some level of expertise and a few insider tricks and techniques up your sleeve.
First things first, you should know that there are different arbitrage strategies you can employ.
Crypto arbitrage methods
Spatial arbitrage, considered the most fundamental form of arbitrage, is the practice of buying and selling cryptocurrencies on two exchanges at the same time to make a profit from market inefficiencies.
A common example is acquiring crypto from an exchange with a lower price and then immediately selling it at a greater price on the second platform. This method also capitalizes on geographic differences. For example, you can take advantage of the difference in the supply and demand of Bitcoin in two different regions.
Triangular arbitrage is another popular method where you trade three or more digital coins on a single exchange to take advantage of the price discrepancy of one or two cryptocurrencies. A common example is when a trader creates a trading loop that starts with Ether and ends with Ether.
Also known as convergence arbitrage, this method works by purchasing a digital coin on one exchange and then selling it on another exchange. It’s a basic and straightforward form of arbitrage where the trader can generate profit from the price differences between two exchanges. While it may seem easy enough, you’ll need to crunch the numbers as fast as possible to beat other traders fishing for the same opportunities.
Flash loans have exploded in popularity, being the breakthrough development in decentralized finance (DeFi). Flash loans allow users to borrow money quickly without passing a credit check or putting up collateral. This development pushed exchanges to make switching between cryptocurrencies easier and quicker. For traders, this means they can make substantial earnings trading different cryptocurrencies than just one or two.
Savvy traders who are keen on placing high-volume trades can employ the statistical method. It involves executing arbitrage trades at scale by using bots, mathematical models, and quantitative data. With these tools, traders can maximize their profit by estimating the minute price difference of currencies across multiple exchanges, after all the transaction fees have been taken into account. This method also allows traders to trade at a higher frequency, which could result in greater profits.
Important things to know before trading
Understand the risks
While crypto arbitrage is generally considered a low-risk strategy, poorly executed trades could lead to significant losses. The most common risks associated with arbitrage include hefty transaction fees, timing and wallet issues, and technical know-how barriers.
Even small mistakes, like confusing one digital asset for another due to spelling similarities, could cause major damage. Using the right strategies and expanding your knowledge of arbitrage could help you mitigate risks.
Study market sentiments and price predictions
Beginners are more prone to making hasty trades, especially if you add the pressure to act quickly into the mix. But arbitrage goes beyond spotting price discrepancies and capitalizing on them. Expert traders would carefully analyze market sentiments and employ predictive pricing strategies before making a move. While it does require advanced knowledge, beginners have multiple resources at their disposal. They can make use of platforms that automate the process of finding price discrepancies across different exchanges.
Arbitrage trading has gained traction among seasoned and beginner traders alike as it allows traders to maximize gains with relatively lower risk. If you use the right strategies, arbitrage trading could be a great source of passive income that requires minimal effort.