Jul 24, 2020

9 min read

Bitcoin Arbitrage Is Possible, But Not The Way You’re Doing It

In an emerging asset class that splits its marketplace between hundreds of different trading venues, sophisticated investors may hunt for arbitrage opportunities-this, in a nutshell, is why many have been chasing Bitcoin arbitrage for the last decade.

Even after ten years of maturation, Bitcoin is certainly still apt for arbitrage opportunities-that’s why SFOX offers a comprehensive arbitrage alert system-but the precise method a trader uses to try to capture arbitrage could make the difference between a sustainable strategy and a fool’s errand. In particular, while it might seem intuitive to capture Bitcoin arbitrage by opening and maintaining accounts at multiple Bitcoin trading venues, this strategy actually introduces trading inefficiencies that can erase the margins from any arb opportunities you may find.

On the other hand, a single point of access to the entire Bitcoin market can allow a trader to overcome these inefficiencies, seamlessly identifying and capturing Bitcoin arbitrage from a single interface that’s facilitated over $12 billion in transaction volume among leading crypto funds and traders since 2014. Today, we’re taking traders behind the scenes of how SFOX’s single point of access to the global crypto market makes sophisticated trading strategies like Bitcoin arbitrage uniquely feasible at scale.

The Problem: Bitcoin Arbitrage Fails If You Introduce Your Own Inefficiencies in an Effort to Capture Market Inefficiencies

Broadly speaking, there are three buckets of inefficiency to which an ill-conceived Bitcoin arbitrage strategy can fall victim: capital inefficiencies, operational inefficiencies, and infrastructural inefficiencies.

Capital Inefficiencies

However, the devil is in the details, and the details make this strategy much less appealing in terms of efficiently and scalably deploying capital. In the first place, if one is maintaining holdings at multiple trading venues in order to arb BTC or secure the best BTC price when trading, then, necessarily, one will only be able to deploy a fraction of one’s capital with each trade. Even if a fund only spreads its capital across three exchanges, that means they’ll only be able to execute trades with one third of their capital at a time, assuming an equal distribution of funds across the exchanges. That introduces a significant scale limitation on active crypto traders.

On top of that, traders specifically looking to execute Bitcoin arbitrage strategies at scale can find themselves hampered by the costs-both in terms of money and time-required to maintain a proper balance of funds across trading venues. In order to reliably capture arbitrage while maintaining accounts on multiple trading venues, one must have both USD and BTC holdings on these various venues so that one can simultaneously buy and sell BTC on the appropriate venues when mispricings arise (assuming that BTC/USD is the pair that one is arbing). That requires active monitoring and reallocation of funds to ensure that particular trading accounts don’t run out of BTC or USD as arbs are executed-and that process can cost bps (in wire, network, and trading fees) and time (especially in the transferring of BTC). The result is that the Bitcoin arbitrage opportunity may be gone by the time one’s funds are in position in the appropriate accounts, or else the fees incurred may have canceled out the arbitrage altogether.

Operational Inefficiencies

Especially in this era when many trading venues are only just beginning to take crypto reporting seriously, the reporting tools available can vary widely, both in terms of formatting and in terms of the actual information available, from one venue to another. This can make basic operational tasks comically challenging-setting aside the matter of filing taxes, for instance, the even more basic task of understanding one’s P&L can require some serious heavy-lifting when adjudicating multiple proprietary, incommensurable transaction reports.

This problem shows its true colors, though, when we consider the most basic “operational” task a trader might complete on a regular basis: simply determining which trading venue has the best price for BTC at any given time. It’s all well and good to say that one is going to open multiple trading accounts in order to capture Bitcoin arbitrage or always find the best price when buying or selling BTC, but how does one expect to actually track the prices of BTC on all of these venues at once?

  • A trader might all the accounts open in separate tabs on a browser and feverishly check them manually, but that’s neither scalable nor sustainable.
  • A trader might engineer a single, automated stream tracking and comparing prices on all the trading venues in question, but that’s easier said than done. This kind of system requires years of time and millions of dollars to build in a reliable and secure way (trust us: that’s exactly what we built at SFOX!).

Infrastructural Inefficiencies

Multiple trading venues introduce multiple potential points of failure in one’s trading infrastructure, which has the potential to significantly undermine a robust trading strategy-especially given the fact that trading venues have recently been wont to experience unexpected outages during times of increased market volatility. At best, an unexpected outage can undermine one’s ability to capture Bitcoin arbitrage opportunities, which, historically, have cropped up more frequently in times of higher market volatility; at worst, sudden exchange outages can leave one unable to edit one’s open orders on the exchange in question.

Bitcoin arbitrage is a delicate balancing act between capitalizing on market inefficiencies without falling prey to other market inefficiencies in the process; and, when one tries to arb from distinct accounts at multiple crypto trading venues, those potential inefficiencies are legion. SFOX’s integrated platform, in contrast, was custom-made to make Bitcoin arbitrage and other global crypto trading strategies reliably efficient at scale.

The Solution: A Maximally Efficient Trade-Routing System that Captures Marketwide Crypto Prices without Requiring Separate Account Management

Putting Capital to Work Efficiently on All Crypto Trading Venues

One consequence of this model is that traders and funds don’t need to split their capital between multiple balance sheets at multiple exchanges: by using SFOX, they can trade using 100% of their capital and have that capital automatically routed to the trading venue with the most advantageous pricing.

The capital efficiency of this model is even more obvious to traders running serious Bitcoin arbitrage strategies: the only “transfers” or “balancing” they need to manage are fund deposits into their SFOX account. Once their USD or BTC are in their SFOX account, those funds can be routed to any major crypto exchange or OTC desk using SFOX’s smart-routing order types in an average of 5 milliseconds, capturing mispricings almost instantly without incurring transfer or network fees in the process. In fact, SFOX’s order book actually shows “arb” in place of “spread” when an arbitrage opportunity appears, making it all the easier to recognize and capture crypto mispricings.

Operational Unity is Operational Efficiency

A single trading interface also means a single transaction report that captures a trader’s entire trade history on SFOX in an easy-to-interpret table, providing all the difficult-yet-necessary details like USD values for crypto-to-crypto trades. That means fewer headaches for active traders-and their accountants!

Serious Infrastructure for Serious Traders

By the way: for more advanced and automated traders, SFOX also has a reliable and thoroughly documented API, which allows traders to plug into and leverage all of these platform benefits in an automation- and bot-friendly environment.

It’s All About Tools

For more sophisticated crypto players, though, there’s a much subtler risk of bag-holding of which to be mindful: the risk of creating more inefficiencies for oneself than the market inefficiencies one is trying to capture through a trade.

The world of crypto is especially risky in this regard: as an emerging market, one might be rightly tempted by the potential mispricings one could potentially capture through strategies like Bitcoin arbitrage, yet in many cases, the infrastructure for professional trading is itself inefficient.

On the other hand, you could choose SFOX and join a community of sophisticated traders who have been quietly getting edge on the crypto market for over half a decade. Sign up for free now and check out all the tools at the pro crypto trader’s disposal.

Originally published at https://www.sfox.com on July 24, 2020.