What is Bitcoin arbitrage?

The idea that each crypto exchange provides a particular price for Bitcoin gave rise to the concept of arbitrage. Crypto arbitrage is the practice of purchasing for example bitcoins at one market and selling them at another, where the price is higher.

Different Bitcoin exchanges often have different prices for given crypto asset, because of the way Bitcoin price is calculated, so certain individuals would continue to take advantage of this and make income from thin air. In this article we will clarify what crypto arbitrage is and how it is done.

Why do Bitcoin and cryptocurrencies have value?

Bitcoins and crypto assets in general are appreciated because they’re useful as a form of money. They have the characteristics of money (durability, portability, fungibility, scarcity, divisibility and recognizability) relying on the properties of mathematics rather than on physical properties (like silver and gold) or confidence in central institutions (like fiat currencies). In short, Bitcoin and cryptocurrencies are powered by mathematics. With these characteristics, all that is needed for a type of money to retain it’s value is confidence and acceptance. In the case of Bitcoin, this can be determined by its rising pool of users, traders and start-ups. Like for any currencies, the value of Bitcoin derives purely and strictly from individuals able to recognize it as payment.

How the price of cryptocurrencies is calculated?

Before we can think about arbitration (i.e. purchasing at a low price and selling at a higher price) we need to clarify what cryptocurrency price actually implies. In theory, the price of a crypto asset is determined by supply and demand. When demand for particular currency increases, the price increases, and when demand falls, the price falls. In practice on any crypto marketplace, the price of Bitcoin for example shall be determined by the last transaction made on that platform. Because various markets have different amounts of buyers and sellers with different priorities, it is normal that prices do not match 100%.

You can think of crypto exchanges as closed markets that are not explicitly connected. On top of this, certain platforms have very small trading volume, which makes Bitcoin’s price far more competitive. As a consequence, certain people are attempting to purchase bitcoins “for free” on one platform and then offer them at a higher price on another platform.

Example of arbitrage in crypto markets

There is a gap in certain capital markets between the buying price and the selling price of an asset, which is called “spread”. However, this specific instrument can be exchanged around the planet. Prices can fluctuate briefly, allowing an arbitrator the chance to make a profit by purchasing it in one market and selling in other markets.

Let’s see a basic example of arbitration to explain how arbitrage is handled. Assuming the price of Bitcoin on Bitstamp is $11 500, whereas the price of Bitcoin on Bitfinex is $11 550. The cost differential is $50, and it is a good opportunity for arbitration. Let’s suppose you ‘re purchasing 100 bitcoins on Bitstamp at $11 500 apiece, and then you’re selling them on Bitfinex exchange for $11 550. You’d make $50 for every Bitcoin exchanged. If we multiply 100 Bitcoins by $50 you’ll see that final profit is $5 000.
Pretty neat, but with one caveat, we need a relatively large amount of capital in order to make a substantial profit via arbitrage, in this example the capital needed is $11 500 x 100 = $1 150 000.
This inconvenience can be avoided if we are trading Bitcoins on margin – number of exchanges and forex brokers offer margin trading for crypto with leverage of 1:5, 1:10, 1:20, or even more.

Caveats of Bitcoin arbitrage on crypto exchanges

You’ll certainly face some obstacles as you attempt to arbitrate:

• It can take some time to confirm transactions (to and from exchanges) and the price of Bitcoin could change during that period;
• Many exchanges demand substantial authentication steps in order to transfer a large quantity of bitcoins;
• Exchange fees, ignored in the above example, are going to eat away at your profits;
• The volume of transactions on both platforms must be large enough to meet these huge orders of purchasing and selling;
• Bear in mind that price fluctuations across exchanges can often represent technological problems or credibility concerns. An important illustration is what occurred in the last days in Mt. Gox, when the price of Bitcoin was suspiciously low as customers could not trust the exchange to permit them to withdraw their assets (i.e. there weren’t many buyers on the exchange).

Software used for crypto arbitrage

The above caveats can be avoided by using specialized software for arbitration and brokers, offering margin trading and CFDs on crypto assets. Since arbitrage trading conditions tend to persist for a rather short period of time (often just a few seconds or a minute), it is very time-consuming to make arbitrage calculations by hand or to execute trades manually on different exchanges. Traders therefore use advanced software arbitration tools that can immediately identify and, ultimately, quantify arbitrage opportunities. We can define three categories of software applications that are widely used for arbitrage trading:

• Automatic Trading Software
• Notification Programs
• Remote Alert Services

The first form of technology used in arbitration trading is algorithmic trading software. This sort of arbitration software is installed directly on a brokerage trading platform such as MetaTrader 4 or MetaTrader 5. Whenever the arbitrage trading program detects an arbitrage conditions, it shall immediately execute the necessary transactions on behalf of the trader.

Some traders tend to make the final FX trading decisions themselves, they may use market notification tools instead. Unlike automated Forex arbitrage trading applications, this category of software continuously checks different stocks, instruments or brokers for the purpose of arbitrage trading opportunities. If such an opening is found rather than the transaction being carried out automatically, the trader would be notified of the opportunity, who will then decide whether to place the trade.

There are a range of traders who, instead of operating their own software systems, rely on what is regarded as the “remote alert service”. Access to such service allows them to receive an automatic trading opportunity notifications in the same manner as they would integrating their own software programs. The difference here is that alert signals are given by software running at another location, outside the trader’s own network or computer which may expose privacy concerns and can lead to significant delays.

Is arbitrage trading illegal?

Crypto arbitrage is completely legal as the only thing that is being done is exploiting price gaps between exchanges. A person conducting arbitrage is just buying and selling as any other trader would do.

How to profit from crypto arbitrage strategy?

As a retail trader, you may notice that coming across brokers suitable for crypto arbitrage is a bit uneasy task. In order to gain consistent profits with this strategy, it is recommended to find a good combination of a Fast Price Feed Provider (Fast Broker) and a Slow Trading Broker offering leveraged trading on crypto assets. By using arbitrage expert advisor the account performance will depend on the Internet speed, geographical location of your PC system and the hardware on which MetaTrader terminal is run. The smaller the ping to the Fast Price Feed Provider (Fast Broker) and the greater the Ping to the Slow Broker, the better the performance of the Expert Advisor used for arbitrage will be.

Conclusion

Overall, cryptocurrency arbitrage may be an opportunity to make some passive income, but at the same time it involves risks. The forex market is considered the largest financial market globally. Trading in pairs is one of the most common strategies some traders may shy away during times of volatility. Thankfully, specific strategies, such as high-frequency trading, can help whether such conditions and, at the same time, help close market gaps and increase their efficiency.

Arbiter Forex Arbitrage EA

Latency arbitrage involves taking advantage of slower quotes from one broker by predicting that they will eventually match the faster quotes from another broker. This allows traders to profit by anticipating market movements and placing trades in the right direction. These price differences may only last for a short time, but they can still be used to make substantial profits. The idea behind latency arbitrage is to exploit these delays in order to gain an advantage in the market.

Basic settings of Arbiter Forex Arbitrage EA

1. License Number – This is where you can enter your purchased license number to remove the restriction on only being able to trade on demo accounts.
2. Operation Mode – Choose to switch from SLOW broker (the account on which trades are made) to FAST broker (the account from which the fast quotes come). The Expert Advisor has to be installed on two MetaTrader platforms – one acting as a server, the other as agent on the same local computer. The FAST broker (agent) sends price quotes from fast broker to the SLOW broker (server) from the predefined trading instrument. If price discrepancy occur between slow and fast broker, the EA attached on server will open position in the direction of fast broker’s quotes.
3. Server Port – The computer communication port used for data exchange between the agent and server. The chosen port must be unused by other software.
4. Broker Color – The color of the price lines from FAST broker (agent) displayed on chart of theSLOW broker (server). Used for important initial price alignment between quotes of brokers.
5. Symbol on SLOW broker – Which trading symbol should be arbitraged on SLOW broker (server). Trading symbols between brokers can differ in their names, here is the place to specify the symbol on the SLOW broker (server).
6. Trading Start (Hour) – When to start trading. This is the hour of the local time window for automated trading.
7. Trading Start (Minute) – When to start trading. This is the first minute of the local time window for automated trading.
8. Trading End (Hour) – When to stop placing trades. This is the end hour of the local time window for automated trading.
9. Trading End (Minute) – When to stop placing trades. This is the last minute of the local time window for automated trading.
10. Trade Type – Instructs the EA to execute only buy orders, sell orders or both.
11. Auto Price Alignment – In SLOW broker (server) mode, this setting allows the EA to periodically adjust the starting point of quotes between slow and fast brokers to compensate for any deviations that occur during the trading session.
12. Manual Price Alignment (+/- points) – In SLOW broker (server) mode, if you disable auto price alignment, you need to manually match the prices between Agent and Server for the given instrument. It’s important to do this correctly because it allows the EA to set the same starting point for prices between slow and fast brokers, which is needed to calculate price deviations and make trade decisions.equal starting point of prices between slow and fast broker in order to calculate price deviations and make trade decision.
13. Gap Size (points) – In SLOW broker (server) mode this value is used to trigger the trade – if there is a gap between quotes of slow and fast broker more than selected amount in absolute points. During highly volatile sessions this value should be increased and vise-versa.
14. Maximum Position Holding Time (seconds) – Opened position by the EA will be closed automatically after the defined amount of time when EA operates in Turbo Mode.
15. Auto Volatility Filter – In SLOW broker (server) mode, this setting tells the EA to automatically check if the current market volatility is high enough before opening a new position to avoid false trade signals caused by market noise.
16. Manual Volatility Filter (points) – Manually set volatility threshold as points in respect to current symbol in order to protect yourself from market noise, has effect when the Auto Volatility Filter is disabled.
17. Turbo Mode – In this mode the EA will not set SL and TP levels, instead positions will be closed only after maximum position holding time was reached or if as soon as current position profit become positive. All positions in this mode are closed very quickly (sometimes under 1 sec.), utilizing the price discrepancy between brokers more efficiently.
18. Stop Loss (points – does not have effect when using Turbo Mode) – The protective stop-loss in points used to preserve the account capital. This parameter has no effect when EA operates in Turbo Mode.
19. Take Profit (points – does not have effect when using Turbo Mode) – Profit target in points. The trades are closed either by stop-loss or by take-profit. Do not set this value too close to the current price. Recommended SL/TP ratio is 2:1. This parameter has no effect when EA operates in Turbo Mode.
20. Lot Size – The volume of every position, adjust this according your risk management and account balance.
21. Display Log – For debugging purposes, displays in MetaTrader journal messages from the process of the EA.
22. Enable Alerts on Deal – Display alert messages in MetaTrader platform when a trade is made by the EA. Use this to get an idea if current slow broker can be exploited by arbitrage without opening a trade (remember to disable Algo Trading in MetaTrader platform first before using this).
23. Display Screen Statistics – Whether to display on-screen statistical information related to EA’s parameters. Disable this option if you have too many graphical objects on chart or small-sized monitor.

Example parameters of the Arbiter Forex Arbitrage EA

One important part of the setup process of the Arbiter Forex Arbitrage EA is the price alignment offset. Since the quotes of the slow broker always try to catch-up quotes of the fast broker, we have to initially align them (set the equal starting point). If quotes from the fast broker are not properly aligned with the quotes from slow broker, false trading signals may be generated, leading to losing trades. Keep an eye during the trading session on the EA and – if needed – adjust manually this offset.

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