Regarding arbitrage, bitcoin is only the newest phase of a successful financial strategy in thousands of years. There is a lot of strategies you can apply to financial investment to make a profit. In this article, we will look at what bitcoin arbitrage is and how it comes about.
If you missed Part one regarding Arbitrage in Crypto CLICK HERE.
What is arbitrage?
Arbitrage is when one asset is bought or sold instantaneously. A security is purchased and sold on separate exchanges to profit from the price difference between the two.
Let us say an asset is trading at $200 on exchange X and on exchange Y it is $198. An investor now come to purchase the asset at $198 on exchange Y then sells it for $200 on exchange X. this investor has now made a $2 profit without any risk incurred.
BitcoinMost of the time it is arbitrage trading that keeps the prices of assets and securities at approximately the same rate across exchanges. This is because once someone notices a price difference, they will capitalize on it right away. In today’s stock market you can have a high-frequency trading algorithm do the work for you. The purpose of it is to look for arbitrage openings and automatically implement the trades.
What is bitcoin arbitrage?
Bitcoin, in general, is a liquid asset as it is maturing. This makes finding a price difference across exchanges a lot simpler. Bitcoin arbitrage is basically when bitcoins are bought for a low price on an exchange then sold on a trade that has the rate slightly higher.
Usually, the amount of bitcoin differs from exchange to exchange, and This is mainly because the markets aren’t linked directly. It is also because, on a lot of exchanges, the trading volume is so low that the price will not alter to the average immediately.
Why does bitcoin arbitrage occur?
A collection of market factors can bring about bitcoin arbitrage opportunities. Below are some significant factors to keep in mind as you take on bitcoin arbitrage.
The variation of liquidity across exchange
A variety of exchanges will have order books that are different, which differ extensively depending on their provision of liquidity to bitcoin. In other words, it is the ease of converting bitcoin to cash via an exchange with as little loss as possible.
Buying bitcoin via an exchange using a scant order book may result in disbursing a higher amount than if you had purchased using a fuller order book. Even though both order books may have the same bitcoin price, people could have small bitcoin orders at high prices. Immediately after you purchase all the lesser orders, you have to go further in the order book and fill the rest of the order. At this point, the sparse order book increases your costs.
The possibility of a big trade on one exchange and not the other
A massive trade can tilt the order book slightly!
Even though a big order can influence the price of bitcoin directly and swiftly on its exchange, it will probably not have the same effect on other exchanges. This will form a difference in bitcoin prices from one exchange to the other with or with no large orders.
Different exchanges accommodate different clients
Exchanges a created based on a variety of traders. Therefore arbitrage opportunities a formed this way. You can discover breaches in the order books among large limit orders left open by clients in exchanges for institutional traders. However, if it were on an exchange that has a broader and large retail investor clientele those gaps may not be found. Just so the breaches form arbitrage opportunities. You may purchase bitcoin via a retail-based exchange, and immediately make a sell order in a particular gap way into the order book of the institutional exchange with the intention of generating instant profit.
People have different views on the quality of exchanges
There would be a lot less bitcoin arbitrage opportunities if cryptocurrency exchanges were seen as equal by everybody. The bitcoin price would be more steady, and order books would look more similar. However, the fact is that people do not see exchanges as being equal. Some people see exchanges as well-nigh reliable, having better or worse fees, either fast or slow transaction time, more or less liquid and best or least security. Perceptions can make a particular exchange’s order book differ massively from another’s. If one is keen on trading across these exchanges paying attention to common sentiment and not get hooked up in it, they may discover arbitrage opportunities.
Market demand varies by country
The popularity of cryptocurrencies varies in different countries all over the world. The narrow-minded nature of a lot of the exchanges in various states results in the supply and demand of bitcoin being controlled by national borders.
Foreign currency rates influencing prices
When considering global bitcoin markets, demand is not the only feature that leads to arbitrage. Exchanges rates on currencies may twist the price of bitcoin through exchanges as well.
Consider a situation whereby the US dollar increases against the KRW. At the same time, bitcoin price stays constant on the Korean and US exchanges. With the assumption that you can trade in the UK and Korean exchanges with no hassle and minimal fees. It may be an excellent opportunity to exchange USD for KRW, purchase bitcoin via Korean exchange then sell the bitcoin on the US exchange.
The Difference In the deposit and withdrawal times of exchanges
Assuming you could transfer your fiat and cryptocurrencies across all exchanges to and fro arbitrage opportunities would be a lot less. The instant and easy movement of money would fix any inconsistencies of prices that occurs between exchanges. Different exchanges have different time durations of the in and out movement of crypto and fiat. For instance, some exchanges will take days to exchange and send fiat, where others take minutes. Exchanges also vary in their bitcoin withdrawal policies.
That ineffectiveness of the market results in exchanges that have slower deposit and withdrawal times taking longer to catch up with market sentiment. On the other hand exchanges with faster deposit and withdrawal processes will catch up a lot quicker. This difference creates price inconsistencies. Nevertheless, withdrawal times that are longer make it difficult to capitalize on arbitrage opportunities.
Issues with bitcoin arbitrage
Although it is common to spot discrepancies that bring forth bitcoin arbitrage in exchanges, a lot of bitcoin exchanges have pricy withdrawal processes. They also charge exchange fees for trading bitcoin for US dollar or any other currencies.
Bitcoin exchange expenses can result in a situation whereby your profits made through arbitrage are lost. In many cases, people discover that they will not only fail to make money, but they will lose money instead.
Another problem is the bitcoin technology called the blockchain. The blockchain is quite safe, but it is very slow. The confirmation of a transaction can take more than an hour and transfers cannot be completed.
Bitcoin arbitrage, in my opinion, is a great strategy to make a profit. However, the approach deals with the staring at the computer screen all day to monitor bitcoin prices. Therefore it may not be suitable for everyday investors with no time to spare. This approach is more appropriate and profitable in the long run.