Creating Arbitrage Opportunities in Crypto
With the ongoing emphasis towards investing in crypto long-term, or even trading it on the short-term based on technicals, many of us forget that there are strong arbitrage opportunities available. Arbitrage generally refers to transactions that are riskless and centered around finding mismatched pricing across various markets.
The crypto market has only really been around for a decade, and is still very much in its infancy. This means that the pricing inefficiencies are still very much a thing in these markets. If you were to look for those same inefficiencies in equity markets, they likely wouldn’t even be there. However, there are mismatches in prices across different crypto markets, so money can be made by buying something on one exchange, moving it to another, and then selling it again.
Why Traditional Arbitrage Is Difficult
However, a lot of this is nearly impossible without having massive amounts of money. This is due to the fee withdrawal fees present on most markets and the need for large sums to make it profitable.
You have to pay for the buy and sell commissions, as well as the withdrawal fee, which mean the difference in prices needs to be pretty big. You also need to hope all three transactions are completed before the prices change.
It is possible to execute parallel loop arbitrages where you must own the second cryptocurrency already on the second exchange. As you make the purchase on the first exchange and transfer the funds to the second exchange, you would already own that second cryptocurrency on the more expensive exchange and would sell it back to the “base cryptocurrency.” This method helps eliminate the time restriction, but requires you to have twice the funds available at the time of the transaction.
Additionally, the technology required to do this at a high level isn’t available to the average retail investor. At this point, it becomes more like gambling and isn’t something that should be undertaken lightly. All is not lost though. There are other ways to do extremely well in the crypto markets while minimizing risk.
Proof-of-Stake Creates Arbitrage
One of the trends emerging right now is proof-of-stake (PoS) cryptocurrencies and the third-party staking services that make it possible for users to benefit from this. These services stake the coins on the behalf of users and save them from needing to accumulate the technical know-how.
This is another form of setting up a mining rig, but is much less risky. Miners generally require a more significant capital investment in the actual mining technology. Proof-of-stake requires that you own a quantity of coins. Ideally, these are cryptocurrencies you are already interested in owning. Then it isn’t really an extra risk to you as a “staker” because you retain ownership of your coins, yet store them with someone else.
Both mining and staking are technically prohibitive for most laypeople, which is why using third-party services is necessary for some people. However, before you go and give all your coins to a third-party staking service, there are two risks to be aware of. In particular:
- Your private keys are being held by someone else and it is possible that they could go bust (or have a Quadriga-like problem)
- The third-party services will accumulate a massive amount of voting rights while holding the coins, which could change the development and policy of these coins
But if you understand those risks, then there are huge potential returns available. Cosmos can yield between 7% and 20%, and the user retains ownership of the coin. As more coins move to PoS (Ethereum is planning on it in the near future), more opportunities will open up for those who wish to take this modified version of a hold position.
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