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  • Writer's pictureRodney Alkins

How to Earn low risk profits with Arbitrage

Arbitrage trading is a relatively low-risk trading strategy

Arbitrage trading is a relatively low-risk trading strategy that takes advantage of price differences across markets. Most of the time, this involves buying and selling the same asset (like Bitcoin) on different exchanges. Since the price of Bitcoin should, in theory, be equal on Binance and on another exchange, any difference between the two is likely an arbitrage opportunity.

This is a very common strategy in the trading world, but it’s mostly been a tool of large financial institutions. With the democratization of financial markets thanks to cryptocurrencies, there might be an opportunity for cryptocurrency traders to take advantage of it, too.

Almost Guaranteed Income

What if you could guarantee yourself a profitable trade? What would it look like? You’d have to know before even entering the trade that you were going to make a profit. Anyone who could have that kind of edge would exploit it until they no longer could.

While there’s no such thing as guaranteed profit, arbitrage trading is the closest you’ll get. Traders compete ferociously to get the opportunity to enter these types of trades. For this very reason, profits are generally very slim in arbitrage trading and depend heavily on speed and volume per trade. That’s why most arbitrage trading is done by algorithms developed by high-frequency trading (HFT) firms.

How does Arbitrage Work?

Arbitrage trading is a trading strategy that aims to generate profit by simultaneously buying an asset in a market and selling it in another. This is most commonly done between identical assets traded on different exchanges. For instance buying a crypto asset on Binance at a lower price and selling on Atomic Exchange at a higher price. The difference in price between these financial instruments should, in theory, be zero since they’re quite literally the same asset.

The challenge an arbitrage trader, or arbitrageur, has is not only finding these pricing differences, but also being able to trade them quickly. Since other arbitrage traders are likely to see this difference in price (the spread) as well, the window of profitability usually closes very fast.

On top of that, since arbitrage trades are generally low-risk, the returns are generally low. That means arbitrage traders not only need to act quickly, but they need a lot of capital to make it worth it.

You might be wondering what types of arbitrage trading is available to cryptocurrency traders. There are certain types to take advantage of, and I will list the main one that an every people use.

Exchange arbitrage

The most common type of arbitrage trading is exchange arbitrage, which is when a trader buys the same cryptoasset in one exchange and sells it in another.

The price of cryptocurrencies can change quickly. If you take a look at the order books for the same asset on different exchanges, you’ll find that the prices are almost never exactly the same at exactly the same time. This is where arbitrage traders come in. They try to exploit these small differences for profit. This, in turn, makes the underlying market more efficient since price stays in a relatively contained range on different trading venues. In this sense, market inefficiencies can mean opportunity.

How does this work in practice? Let’s say there’s a price difference for Bitcoin between Binance and another exchange. If an arbitrage trader sees this, they would want to buy Bitcoin on the exchange with the lower price and sell it on the exchange with the higher price. Of course, the timing and execution would be crucial. Bitcoin is a relatively mature market, and exchange arbitrage opportunities tend to have a very small window of opportunity.

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