- Use Cases
One trading approach with more potential in cryptocurrency than traditional finance is arbitrage trading. This is because the crypto market is highly volatile compared to traditional financial markets. Crypto asset prices tend to deviate significantly both over time and between trading venues. Because crypto assets are traded globally 24/7 across hundreds of exchanges, there are far more opportunities for crypto arbitrage traders to find profitable price discrepancies. This is a popular strategy with hedge fund managers.
Examples of crypto arbitrage trading strategies
There are many arbitrage strategies available in the crypto market:
This strategy, also known as cross-exchange arbitrage, is the simplest form of arbitrage trading. With this strategy, a trader looks to take advantage of the difference in the price of an asset across two centralized exchanges (e.g. buying Bitcoin on Coinbase and selling it on Binance).
Decentralized arbitrage is similar to cross-exchange arbitrage but involves a decentralized exchange (DEX) instead of two centralized exchanges. These arbitrage opportunities are created when the price of a traded pair on a DEX is different from the spot price on a centralized exchange.
Instead of capitalizing on the price difference for one asset across multiple exchanges, triangular arbitrage takes advantage of the price difference between multiple cryptocurrencies. In some cases, the trader may end up with the same asset they started with. A trade where Bitcoin is exchanged for Ethereum that’s then exchanged for Solana that’s then exchanged for Bitcoin is an example of triangular arbitrage.
This strategy looks for arbitrage opportunities between derivatives like options and futures contracts and their underlying assets.
Statistical arbitrage uses mathematical models to execute trades algorithmically. This is a high-frequency trading strategy that relies on using a high volume of trades to generate significant profits from otherwise insignificant price differences. Trades can be cross-exchange or cross-asset.
The risks of crypto arbitrage trading
While crypto arbitrage presents enticing opportunities for potential profits, it's not devoid of risks. Like any trading strategy, it requires a careful understanding of market dynamics, price fluctuations, and other factors that influence the profitability of trades.
Specifically, traders need to remain cognizant of the execution risks involved in the timing and management of trades, the impact of transaction fees, and the use of arbitrage bots. Unmanaged, these elements can erode profit margins and result in losses.
Execution risk in arbitrage trading
The main risk when making arbitrage trades is execution risk. This is the risk that the price of the asset traded will change in an unfavorable direction while the trade is being executed, turning a positive arbitrage opportunity into a money-losing trade.
In some cases, prices can change unfavorably in mere milliseconds, making every moment count, especially when using statistical arbitrage or other algorithmic trading strategies. Execution risk is one of the reasons institutions invest significant capital in high-frequency trading equipment and infrastructure.
Accounting for trading fees in crypto arbitrage
The transaction fees and withdrawal fees on a crypto exchange can eat into profits from an arbitrage trade. Effective arbitrage traders should include these fees when calculating potential profit accurately.
Mitigating risks with arbitrage bots in crypto trading
Because cryptocurrency markets can shift so quickly, arbitrage traders have to execute price discrepancies within a few moments. One method for overcoming this challenge is by utilizing arbitrage bots. These automated trading bots can detect and execute crypto arbitrage trades far quicker than any human can, offering a significant advantage. However, they require technical knowledge to use and can sometimes lead to losses when not managed correctly.
What data do you need for crypto arbitrage trading?
Many hedge funds are looking to expand their arbitrage strategies to include different cryptocurrencies. Their real-time, high frequency, high volume trading requires a large amount of real time price data to support the development and backtesting of their digital asset algorithmic/programmatic trading strategies. Effectively identifying opportunities and developing the necessary trading algorithms is impossible without comprehensive data from the major crypto exchanges and blockchains.
Without comprehensive, granular and unopinionated data, hedge funds cannot enter the digital asset space. Amberdata eliminates the infrastructure setup and maintenance required to obtain digital asset data and is the leading provider of crypto data for institutional investors. We provide blockchain, DeFi, and market data with 24/7 reliability in formats familiar to trading teams.
Request a demo today to learn how our platform can help you succeed with crypto arbitrage and other digital asset strategies.
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