If you are like many people, you’ve probably sought to know how you can increase your value (or make money) with Bitcoin, and cryptocurrencies in general.
And one of the questions you’ve probably asked yourself is ‘can I buy Bitcoin on one exchange and sell on another for a profit?
This is known as Bitcoin arbitrage, a concept borrowed from the stock markets, where investors can buy stock from an exchange with lower price offers and sell them on exchanges with higher price offers.
Before we dive in, an important disclaimer; this post should not be taken as professional investment advice. The content therein is for informational purposes only.
Now, can you arbitrage Bitcoin?
Yes, you can buy bitcoin on one exchange and sell on another and make some profit, but it is never as easy as it might seem. Many obstacles stand in your way, and you may need to do a lot more to succeed.
In our last post, we looked at how Bitcoin exchanges work. It might be helpful to read it first before coming to this one.
As pointed out in that post, there are about 250 crypto exchanges around the globe. Some are global, with a clientele from all over the place. Others cater to specific regions and countries.
The basis of the question of whether you can buy bitcoin on one exchange and sell on another is the fact that prices on these exchanges are not exactly the same. If you did a spot check at precisely the same time, some would be showing rates that are a little higher than those on others. At times we have witnessed a price difference that is as high as 40%.
That was the gap that was witnessed between South Korean crypto exchanges and those in other countries in January 2018.
Now and then huge differences in Bitcoin price have also occurred between exchanges in countries like Zimbabwe and Venezuela and those in the rest of the globe.
In 2017, exchanges operating in Zimbabwe were selling Bitcoin at a premium price that exceeded the global rate by over 10%.
In January 2019, we saw the price of Bitcoin and other cryptos in Venezuela exceed the global prices by a premium of about 40%.
But why is Bitcoin price different on exchanges?
The price of bitcoin like that of any asset in a free market is determined by supply and demand. In particular, the variation in demand for bitcoin in different parts of the globe is the primary cause of the difference in exchange prices.
Some factors influencing the price of bitcoin are global. For example, when the block reward halves after every four years, the supply shrinks for the entire global market and that pushes up the price for all the exchanges in the same way.
However, many local factors could drive the price higher for one exchange and not others. A good example is high inflation and the failure of economic policies in a particular country that an exchange has as a primary market.
Zimbabwe is a good example where inflation has gone really high. At some point the country’s currency became worthless, and people had to look for alternatives. Bitcoin has been one of the other options, and that saw its price in the country has been higher than the global average.
Venezuela has seen poor economic policies by the government coupled by sanctions from the US and others result in high inflation making cryptocurrencies attractive to the population, and that made the price higher in the country than what was available in other countries.
The other factor that influences different bitcoin prices on different exchanges is regulation. Exchanges face different demands, including taxation by various jurisdictions. These translate to different user experiences, fees, demand and ultimately the price.
So, in short, local economic trends, political stability and regulatory policies play a significant role in making exchanges have different Bitcoin and crypto prices.
It is also important to point out that Bitcoin exchanges are independent entities with different business models, fee structures and strategies. In fact, they are mostly silo-ed except for customers who use multiple of them.
Moreover, they have different volumes and trade activity. All these contribute to each having slightly different pricing from the next.
Is bitcoin arbitrage legal?
To some, stock arbitrage may seem unethical. Indeed, it is common for some to ask ‘is arbitrage illegal?’
It could be if someone uses internal information or shares it to those who could use it to their advantage. In other words, if someone leaks information about actions about to be taken, which could affect the stock price, then we are likely looking at illegal activities.
However, if an investor is taking advantage and exploiting the difference in price on two exchanges to make a profit, then there is nothing illegal about it. The same view can be taken on Bitcoin arbitrage.
Challenges to arbitrage Bitcoin
While it is possible to buy bitcoins on one exchange and sell on another, it is not easy. You have to overcome the following challenges to be successful:
High volatility of the bitcoin price
The bitcoin price often changes fast. It is usual for the cryptocurrency gain and loses value in a matter of seconds. And the price change doesn’t always move in the same direction on all exchanges, at least not in the short term (say seconds, minutes and hours).
That means you may see an arbitrage opportunity between two exchanges, but within a few minutes, it gets erased. These fast price changes might require you to act fast; otherwise, a profit opportunity could quickly turn into a massive loss by the time you sell on the other exchange.
Slow fiat payment (depositing) options
On many exchanges, you need to deposit the fiat currency on an account on their platform before you can buy cryptos. You can make a deposit using a bank transfer, debit card or even a service like PayPal.
It turns out, however, that many times it takes a very long time before the money is received on the exchange. With bank transfer, it could take as long as seven days. Considering the volatility of the bitcoin price, waiting that long to exploit price difference on two exchanges is not practical.
Speed is of the essence in Bitcoin arbitrage.
Different requirements by different exchanges to use their service
Huge Bitcoin price gaps usually occur between exchanges in different countries. The requirements to join these exchanges and trade are not the same. Indeed, some are closed off to people in some regions.
For example, someone in America you might struggle to get approval to trade on Chinese exchanges. That means you might miss very lucrative opportunities simply because you couldn’t get a working account on one of the exchanges you eyed for arbitrage. This is mostly the case, especially if you seek to trade large amounts.
The whole situation is complicated by how difficult it is at times to move fiat currency between countries.
The hidden cost of transacting
The Bitcoin prices indicated on exchanges do not include the fees you will have to pay to make a purchase or a sale. These fees are usually added at the point of transferring funds to a buyer or from a buyer. And therefore you may end up learning about them when it is too late to do anything.
It may turn out that the exchange that indicates a lower price charges a lot more fees, which would cancel whatever profit you thought you were going to make.
You will pay fees to sell and buy. You may also pay fees to deposit and withdraw from the exchange.
The fees you may incur extend beyond those charged by the exchange. You also have to pay fees to move funds from your bank account to the exchange account. Also, you may be charged to convert your funds from one fiat currency to the one used on the exchange, and back when you make withdrawals.
When you add all these fees and cost, the total is likely to erase any profit you make from the arbitrage.
What you may do to increase your success with Bitcoin arbitrage.
The first thing you should do is to study the exchanges between which you want to trade and make sure you know how they work. In particular, you should be aware of all the fees you would incur when you buy from one and sell on another. Consider if the cost would eat too much into the price difference.
The second thing to do is to register and get approval on the exchanges you want to trade beforehand. This is part of being prepared so that you are able to act quickly when arbitrage opportunities come.
Given that speed is critical, you always need to have funds ready on exchanges as you wait for an opportunity to act. That means no time is lost. You may need to have both fiat and crypto funds on all exchanges you intend to trade on.
That means if the price is lower on exchange A than on exchange B, you buy on A using fiat already there. You then head offer to B and sell the corresponding amount of cryptocurrency you already have on your wallet there.
All in all, you need to do a lot of learning as well as research before you start doing Bitcoin arbitrage on various exchanges.