For cryptocurrency investors, there are several ways of making profits through the buy and sell of virtual assets. One of such is arbitrage trading which has been classified as a game for whales. If done with great care, it can yield immense profit even though there are possible risks that may occur, according to a recent report by Cryptonews.
What is Arbitrage Trading?
Arbitrage trading is the act of buying and selling an asset at the same time from two virtual exchanges. Here, a trader needs to spot a difference in the price of the same cryptocurrency offered on different exchanges. For instance, Coinmarketcap’s platform currently shows that Bitcoin is trading at $3,898.99 and $4,037.32 on BIT-Z and BCEX respectively.
That being the case, a trader can decide to take advantage of the price difference by buying Bitcoin on BIT-Z and selling it on BCEX. The process can either be carried out manually or automatically with the use of high-frequency trading software that monitors the differential on exchanges. Thus, arbitrage trading is not only used in crypto markets but that of stocks and bonds.
Why Does Arbitrage Occur?
The differences in the price of a particular virtual currency can be attributed to some factors. Notable among them is the geographical location of the exchange which can influence digital currencies on its platform. This is because there is no international price fixed for them.
An instance is the case of Golix, a Zimbabwean-based exchange where Bitcoin was about 30 to 40% higher than what was traded on other exchanges in 2018. The big gap could be blamed on the level of the recession in the country, high demand for Bitcoin, and limited exchanges to meet these demands.
How to Profit from Arbitrage Trading?
While this is another opportunity to earn, one must be willing to invest massively to make meaningful returns from such trades. In this case, up to $100,000 may be required to make the final profit generated from these sales count.
There is also the fees that will be paid for transactions and withdrawals to consider. Thus, spending a couple of dollars as a small investor may not cut it. That is why the process is mostly carried out by whales who own cryptocurrencies in large amounts.
Risks Involved in Arbitrage Trading
Unarguably, the arbitrage opportunity looks good and sounds good, but it comes with its risks. Notable among them is the liquidity problem. While Bitcoin has a large market cap, it may still be difficult to buy bitcoins, up to 20,000 BTC at once, and on completion, the arbitrage opportunity would’ve been lost.
The same goes for being able to sell off such funds before the actual market price of the cryptocurrency catches up with each exchange. On the other hand, buying and dispensing funds may not be a problem for stocks and bonds market given that their market is larger.
That aside, there is also the high transaction fees to consider since they vary from one exchange to the other. Even though there are platforms that do not charge fees, it is possible that it is an unpopular one. Likewise, it may take too long for the funds to be sent back and forth. Thus, for every minute wasted, a trader could end up with losses due to tp the volatile nature of cryptocurrencies.