Arbitrage is the act of the simultaneous buying and selling of the same asset, across two different markets.
For example, if a trader buys an asset at $98 on exchange A and sells the same asset on exchange B at $100, he can immediately make a risk-free $2 profit.
In traditional stock markets, a new order gets paired automatically, to every order across all the available exchanges. In addition, small arbitrage opportunities are identified immediately by automated trading algorithms. For this reason, price differences between brokers tend to be narrowed.
In Bitcoin, exchanges act independently, hence buy/sell orders are harder to match. Liquidity varies across exchanges, which creates price differences and arbitrage opportunities. It should be noted, that a lower price of an asset reflects, in many cases, the exchange’s reputation.
Bitcoin arbitrage may sound like a no-brainer solution to generate passive income. However, there are several parameters that could affect its profitability. Arbitrage is a time-sensitive activity, which means that an opportunity that is available now, may not be after 30 minutes. Bitcoin transactions are very inefficient to that extent. It could take hours until a transaction has been completed in both exchanges that may eliminate this arbitrage.
As time is of the essence, transfer times between depositing fiat money from the bank to the exchange could affect the arbitrary opportunity. Some advisors suggest that traders always keep an amount of money spread across multiple exchanges, waiting for the opportunity. Storing money in an exchange is not ideal though because exchanges have proven to be vulnerable to hackers’ attacks. Therefore, if a trader is security-conscious, he should also calculate withdrawal fees before looking into arbitrage trading.
Additionally, an arbitrage trader should always take into consideration the exchange’s fees. All exchanges apply transaction fees, that vary from one to another and could be up to 0.6%. Because arbitrage needs two transactions to be completed, this fee should be accounted twice.
Bitcoin’s price has risen at such levels, that make arbitrage unattractive. Arbitrage trading requires large volumes, in order to be worthwhile. With this said, there is big risk involved as long confirmation times could cause substantial losses, instead of profits.
Theoretically, it can be. There plenty custom-made calculators available on the web, that are able to show you price differences across exchanges. There are also, many available bots out there, that can automate market orders for arbitrage trading. Nevertheless, traditional arbitrage opportunities are supposed to be risk-free and, in Bitcoin’s case, they are not. Confirmation time is a parameter that will always be unpredictable and the unregulated environment of exchanges’ majority can leave the investor exposed.
Even if profitable, it is highly questionable if Bitcoin arbitrage can be a better strategy to speculate than to hold the digital asset in the long-term. Cryptocurrencies are hyper-volatile and more arbitrage opportunities appear during these price swings, but Bitcoin’s transactional inconsistencies make arbitrage a controversial activity.
As the regulatory framework around cryptocurrencies constantly changes and new technologies are being introduced (e.g. the Lightning Network), times, fees and transactional efficiency could be optimized in the near future. On the other hand, a potential consolidation across exchanges would also close these price gaps and arbitrage opportunities will be decreased.