The Beginner’s Guide to Bitcoin Arbitrage
Last updated: 3/13/19
The fact that each exchange shows a different price for Bitcoin has given birth to the arbitrage phenomena. In this post I’ll explain exactly what arbitrage is and how it is conducted.
Bitcoin arbitrage is the process of buying bitcoins on one exchange and selling them at another, where the price is relatively higher. Different exchanges will have different prices for Bitcoin, and some people manage to take advantage of this and generate profit out of thin air.
If you want a more detailed explanation of Bitcoin arbitrage and how it’s conducted, keep on reading. Here’s what I’ll cover:
- How Bitcoin’s price is determined
- A simplified example of Bitcoin arbitrage
- Barriers to Bitcoin arbitrage
- Bitcoin arbitrage calculator
- Conclusion – Should you try to arbitrage?
Before we can talk about arbitraging (i.e. buying at a low price and selling at a high price) we need to understand what “Bitcoin’s price” really means. On any exchange, the price of Bitcoin is determined by the last trade done on that exchange. Since different exchanges have different amounts of buyers and sellers with different preferences, it’s only natural that prices won’t correlate 100%.
You can view exchanges as closed markets that aren’t directly linked. On top of that, some exchanges have very low trading activity on them which makes Bitcoin’s price on them much more volatile.
As a result, some people try to buy Bitcoins “for cheap” on one exchange and then sell them at a higher price on another exchange. Here is a great video by Andreas Antonopoulos about why arbitrage opportunities exist:
The difference between prices is $87, and this is quite a decent opportunity for arbitraging. Lets say, you buy 100 bitcoins on Bitstamp at the rate of $3862 each, and subsequently you sell them on CEX.io at the rate of $3949 each. In a perfect world you’d make $87 per Bitcoin.
Now let’s get down to the math:
Number of Bitcoins bought in Bitstamp – 100
Price of each Bitcoin – $3862
Total expenses – $3862 * 100 – $386,200
Number of Bitcoins sold on CEX.io – 100
Price of each Bitcoin – $3949
Total revenue – $3949 * 100 = $394,900
Total profit – $394,900 – $386,200 = $8,700
An interesting thing to notice from the example above is that we need a relatively large amount of capital in order to make a substantial profit via arbitrage. However, in real life things are more complicated than the simplified example above.
When trying to arbitrage you’ll probably encounter several setbacks:
- It may take some time to verify transactions (to and from exchanges), and during this time the price of Bitcoin may change.
- Many exchanges require considerable verification steps in order to trade a large number of Bitcoins.
- Exchanges fees, which I have overlooked in the given example, will eat away at your profits.
- Transaction volume need to be high enough on both exchanges to satisfy such large orders of buying and selling.
- Keep in mind that price differences can also reflect technical issues or reputation issues of an exchange. An interesting example is what happened during the last days of Mt.Gox where the price of Bitcoin was extremely low since traders didn’t trust the exchange to allow them to withdraw their funds (i.e. There weren’t many buyers on the exchange).
Now that we know what we will face in a real live Bitcoin arbitrage trade, let’s take an example that includes all of the different variants and fees involved. Relevant fees include:
- Fiat deposit fees
- Fiat withdrawal fees
- Bitcoin deposit fees
- Bitcoin withdrawal fees
- Transaction fees (i.e. trading fees)
I’ve taken the liberty to create some sort of Bitcoin arbitrage calculator using a Google spreadsheet to show you how hard it can be to actually generate a profit.
Take a look below:
If you want to clone this calculator for yourself, feel free to make a copy using this link. As you can see, our “real world” profit comes to about $2,604 while we’ll need almost $400K in capital. All of this suggests that making a profit over Bitcoin arbitrage is quite a difficult task.
If you play around with the numbers a bit you’ll see that the bigger the spread (difference between buy and sell values), the more profitable the arbitrage. However, it still doesn’t amount to much unless you put large amounts of money at risk.
Another thing to take into account is that it can take up to 7 days for fiat deposits to appear on Bitstamp. During that time, the spread can change drastically and eliminate any chance for arbitrage. So, the best tactic would be to keep some fiat currency on the exchange and choose the right time to execute the arbitrage.
Having said that, any time you keep money on an exchange you’re putting your money at risk, as exchanges getting hacked or going out of business is unfortunately still common these days. And as I’ve demonstrated, you’ll need to keep a large amount of money on the exchange in order to be mildly profitable, so I’m not sure it’s worth the risk.
The act of arbitraging Bitcoin is as simple as it may seem at first glance. If you have some extra BTC or cash, you’re welcome to try it yourself. Still, it’s important to know what you’re up against before staring out.
Arbitrage is actually a positive process, unlike speculation, margin trading and other activities that can be viewed as market manipulation, and in some cases may even be truly harmful to the market as a whole.
Bitcoins should have the same price across all exchange. Arbitrage simply helps bring the exchanges together to the same page. As Bitcoin’s market grows, the gap between exchanges will narrow, as more and more people will conduct arbitrage.
Overall, Bitcoin arbitrage may be an opportunity to make some passive income, but at the same time it involves huge risks.
As for the ‘how’, nowadays almost all exchanges have an API which can become a useful arbitrage tool.
Utilizing these APIs will allows you to create a custom arbitrage bot, so that you don’t have to sit in front of the computer all day. Still, even attempting to arbitrage manually can be very beneficial, as long as you watch closely and make sure you are placing simultaneous trades.
My personal opinion is that if you want to make some real profit from arbitraging you have to make it your profession. You probably won’t be able to arbitrage successfully on your first or second try. Like everything else, it takes practice, patience and experience.
If you’ve had any experience with Bitcoin arbitrage I’d love to hear about it in the comment section below.
Moreover, almost all exchanges have an API and these can prove to be very prosperous for you. Utilizing these APIs will give you the tools you need to create a custom arbitrage bot, or hire someone to do it for you. Still, even attempting to arbitrage manually can be very beneficial, as long as you watch closely, and make sure you are placing simultaneous trades.
My personal opinion is that if you want to make some real profit from arbitraging you have to become an arbitrage professional. You probably won’t be able to arbitrage successful on your first or second try. Like everything else it takes practice, patience and experience. If you’ve had any experience with Bitcoin arbitrage I’d love to hear it in the comment section below.
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