Understanding Bitcoin Arbitrage

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If you’ve never heard of Bitcoin arbitrage, but are looking to make some money off of Bitcoin investing, then it’s a concept that you should slow down and take some time to learn about.

The simplest definition of arbitrage is buying something cheap in one market and then selling it expensively on another market. It’s basically making money out of inefficient markets.

Let’s say Bitcoins are selling for $100 on BTC-E but they are selling for $110 on Mt.Gox. In this case, you could buy Bitcoins on BTC-E and immediately sell them on Mt.Gox in order to make a profit off of the difference in prices on the two exchanges. This is called arbitrage and it is a profitable way to make money. The a look for a second on the Bitcoin Ticker to the right of this page and see the major price differences.

So why are their arbitrage opportunities in Bitcoin?

Shouldn’t prices be the same on all markets? Stocks, for example, are often traded on multiple markets, but prices are almost always nearly the same. So why then can the price of Bitcoin vary so much market by market? Currently, the large difference in prices is due more to the growing pains being suffered by exchanges, such as Mt. Gox. Simply put, Bitcoin exchanges aren’t as well developed as stock exchanges, and trading levels are not as high or regulated by natural market forces. In the future the opportunity for arbitrage will shrink massively.

Further, some traders argue that money on certain exchanges, such as Mt. Gox, is worth less than money on other exchanges, such as Bitstamp. The reason for this is because it is actually more difficult to withdraw money on Mt. Gox and can actually take several months to do so. Exchanges that allow people to withdraw faster are thus more highly valued by traders due to the liquidity and ability to quickly access funds.

Digging in a bit deeper into sites like stack exchange I’ve found claims about arbitrage being impossible to conduct since June 2013 when Mt.Gox suspended the withdrawal of USD from their accounts. Since Mt.Gox usually has the higher prices this of course damaged arbitrage efforts. One more claim states that it is possible to arbitrage but since the margins are so low, you will need deep pockets to make substantial amounts of money.

Is arbitrage risky ?

These differences in prices, however, do create unique arbitrage opportunities. We should warn you, however, that while some people claim arbitrage is a “risk free” way to make money, there are indeed risks. For one, Bitcoin trading and withdrawals are still in the nascent stage of development. It can take a long time to conduct and complete a trade, even if you initiate it immediately. Meanwhile, as your trade is being conducted, prices can swing wildly and can change so much before you make a transaction that you may incur losses.

Price differences can also be created due to differences in fees on different exchanges. If one exchange charges higher fees to withdraw or conduct transactions, the price of Bitcoins will most likely be lower to reflect the costs of these fees. At the same time, if another exchange has lower fees, prices will most likely be higher. Sometimes the difference in price between the two exchanges is great enough, however, to still offer profit opportunities. Just make sure you spend time studying the fees on different exchanges and take those into account when conducting trading.

Can I rely on arbitrage for the long term ?

As Bitcoin evolves and becomes more widely used and accepted, prices on various markets should come closer together. This means that over the opportunities to make money through arbitrage will likely shrink. While opportunities will still be available, you will have to look more closely and monitor markets more frequently to notice discrepancies.

If you engage in arbitrage, you should also keep yourself up to date on major changes in the market. It’s possible that changing circumstances are actually the cause behind price jobs on one exchange, and the other exchange simply hasn’t reacted yet. For example, if prices on an exchange favored by European traders suddenly drops by $10, it could because news of a scandal in Europe just broke and North American traders have not yet reacted.

Bottom line – should I do it or not ?

I’ve searched the web quite a long time to find an answer to this and came to the conclusion that just like most things in life you have to try it for yourself to find out. So I’m going to conduct an experiment this week which I will document and post here with my conclusions. In the meantime I’ve found that Bitcoin Analytics supplies some useful information on arbitrage opportunities. There are also some trading bots that claim they can do this automatically for you, but since I haven’t tried any of them (yet) I can’t say for sure.

 

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Brian Booker

An international financial analyst and writer. He has consulted for the Malaysian government, various MNC's, and other organisations. He focuses on currencies, commodities, and emerging South East Asian markets.

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