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How to do arbitrage with Bitcoin?

Undoubtedly Bitcoin cryptocurrency is already socially accepted. All the media report more frequently on it offering more and more details. No matter how big the interest is, so is the gap between fanatics and Bitcoin skeptics. But do not worry about this strategy as we will focus on seeing if you can make money, regardless of the direction of the movement.

Definition of arbitration

The arbitration consists of exploiting at the same time different types of change in different values with a single objective: to obtain profit. Let’s see a simple example that occurs in our daily lives: in an online auction house, someone sells a particular model of computer keyboards for $ 30. We find the same model in the wholesale at 12 euros. Now we have two places that we can use to carry out our arbitration: in this case the wholesale trade, where the offer exists, and the online auction house, where there is demand. Without demand, the seller certainly would not offer his products there. How can we take advantage of this difference and earn money? We will buy the keyboards in the wholesale market and sell them in the online auction house. Not for 30 euros, but for 29, so we are taking some clients from the other vendor. The counterpart of arbitration is speculation. If we continue with our example, as speculators, we will buy and store the keyboards, with the hope that the value will increase and we will earn money selling them afterwards at a favorable price for the traders.

The arbitration strategy

With this strategy, we will exploit the price differences in the individual Bitcoin markets. Bitcoin does not have a central market like the futures market. We can buy a Bitcoin in the A and B market and then sell it in the C market. There we can buy another keyboard again and sell it in the A market. We need at least 2 different accounts in different Bitcoin markets. In both we will need money and bitcoins. The available capital will be decisive to obtain benefits. If we start with 2000 euros, the distribution could be the following:

Market A: cash and bitcoins in each for a value of 500 euros

Market B: cash and bitcoins in each for a value of 500 euros

At the moment we would not buy a full Bitcoin since we only have 500 euros. But that will not bother us when implementing our strategy. Since we can, for example, buy and sell 0.001 Bitcoins.

Arbitration signs

Once our accounts have capital, we can look for signals. The calculation of the difference of both prices is relatively simple:

Market demand price A

Offer price in market B

Offer price in market A

Market demand price B

If the difference is greater than X, then we enter. X in this case will be our expectation of obtaining benefits. The higher this value is, the less signals we will get and the more likely we are to have fewer false operations. For example, for X, we can take $ 20 or $ 1. Which would include enough reserves for fees and transaction costs. We can also include these factors in our formula and expand it:

Differential of the arbitration = Price of the demand in the market A – Price of the offer in the market B – tariffs – transaction costs

Suppose we can buy a Bitcoin at $ 4,400 in market A and sell it in market B for $ 4,250. The gross value of the price difference is $ 50. This value is greater than our minimum difference. Then we will buy Bitcoin (or a part of it) in market A and in market B we will sell the same amount of bitcoins of our shares. Of the $ 50, of course, some will have been lost in fees, et cetera.

Always keep your accounts in mind

The lower the capitalization of your accounts, the faster the following problem will occur: still having a lot of cash in one account, but without many bitcoins while in the other account there are many bitcoins, but without cash. As a result, we are restricted to our operations. We have to wait for Bitcoin to be much cheaper in the market where our cash is located than in the other. Only then can we operate. The alternative would be to balance the accounts. We transfer the bitcoins and the money to balance them, so we will be dividing the risk. Attention: the transaction costs are again paid.

Risks

There are no strategies without risk. The goal of any strategy should always be to earn more money than to lose it. In the arbitration with Bitcoins, we will not position ourselves as classic strategies do. If the market falls or rises it does not matter. Therefore, we are not subject to a market direction. Which sounds like a risk-free strategy at first, but in practice we have some risks that we need to take into account. In the past, it often seemed that the individual bitcoin markets disappeared on the network, due to authorities, operators or hackers. Every time it happened, the users of the bitcoin markets lost a lot of money (bitcoins). This risk also occurs with this strategy. Therefore, we must diversify our assets correctly and have only part of the money and Bitcoins in the bitcoin markets, which is absolutely necessary. Regularly taking out the profits would be very useful. The same applies to payment providers, with whose help we will move money from or to individual Bitcoin markets.

Transactions: time and costs

Individual transactions always incur costs: from the bitcoin market to its own Bitcoin portfolio and vice versa.

Money from the giro account to the Bitcoin market and vice versa

Transfer of Bitcoin from the Bitcoin A market to the Bitcoin B market

When trading in currencies, we are used to ignoring (neglecting) the costs of transactions. Basically, in this case we will not have any. We just have to include the fork. But with Bitcoin we must be very careful. As a rule, you pay for each money transfer or bitcoin. As it can happen, a margin of 10 euros will cause us a loss. Arbitration has worked well in the stock market in the past: you could buy shares on the A stock exchange and sell them on the B stock market at a higher price. Of course, this does not work anymore because countless robots actively exploit such differences or prevent them in advance. There is an advantage in Bitcoin: the strategies of large banks and asset managers are not yet automated in the bitcoin market. Which is mainly due to the low market capitalization. The potential benefit is simply (still) too small for the big players. However, even today it is increasingly difficult to find good opportunities in the Bitcoin markets, since this strategy is no longer a big secret.

Photo by rawpixel on Unsplash


Also published on Medium.

Published inCryptocurrencies

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