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Arbitrage involves attempting to profit from price differences in the same good or product, and crypto arbitrage is no different: Market participants may be able to make money by exploiting price differences for the same cryptocurrency. Those differences may occur across different exchanges or platforms, opening up the opportunity to buy, sell, and possibly generate a return.

Note, though, that arbitrage involves substantial risk, so caution is warranted.

What Is Crypto Arbitrage?

Cryptocurrency arbitrage is a strategy in which market participants buy a cryptocurrency on one exchange, and then attempt to quickly sell it on another exchange for a higher price. Cryptocurrencies are purchased or sold on many different exchanges, and often the price of a coin or token may differ slightly on one exchange versus another.

That’s where the strategy of arbitrage comes in: Similar to using arbitrage in other capital markets, crypto arbitrage is a legal way to earn a potential profit when an asset is selling cheaper in one market and at a higher price in another. That said, crypto arbitrage comes with some potential risk factors.

Why Do Price Differences Exist Between Exchanges?

The regulations of crypto markets are nuanced and varied, and cryptocurrencies are decentralized and therefore (with the exception of stablecoins) not pegged to government or fiat currencies like the dollar. This is one of the primary reasons why the prices of different crypto can vary widely: there is no standard price for any particular coin or token.

Related to this, some crypto exchanges are bigger than others, with higher trading volume. Thus the supply and demand on one exchange could be quite different from another, affecting the price.

Finally, crypto trading fees also vary, and can add to the cost of your transactions.

How Does Crypto Arbitrage Trading Work? A Step-by-Step Look

As noted, crypto arbitrage involves trading the same cryptocurrency for different prices on different platforms or exchanges. Arbitrage comes with the risk of prices changing during the process of buying and selling cryptocurrency. However, here’s how crypto arbitrage might work in theory, assuming prices remain the same.

Step 1: Identifying Arbitrage Opportunities

In a very general sense, identifying an arbitrage opportunity in the crypto market could be as simple as noticing that some type of cryptocurrency, let’s say Crypto X, is trading for $1 on Exchange 1, but trading for $1.50 on Exchange 2.

That price discrepancy means there’s an opportunity to generate a profit by purchasing Crypto X for $1 and then selling it for $1.50.

Step 2: Executing the Purchase and/or Sale

The next step to take advantage of the price discrepancy is to actually execute the transactions. That could be a bit more intensive than it sounds, since you’re trading on two different exchanges or platforms.

But in effect, let’s say you purchase $10 worth of Crypto X on Exchange 1, and transfer it to your crypto wallet. Then, you log on to Exchange 2, make sure your wallet and holdings are connected, and then sell Crypto X for $15.

Step 3: Calculating Profits (and Losses)

When all is said and done, you should now have $15 in cash, a profit of $5 from when you first started (not taking any fees into account), and a 50% return due to your arbitrage activities. Don’t forget there’s taxes to pay, of course.

And always keep in mind that you can lose money through crypto arbitrage, too, such as if the price of the cryptocurrency purchased drops before it’s sold. There’s no guarantee that you’ll come out ahead in the crypto markets.

Common Arbitrage Strategies

There are some different ways that crypto arbitrage can be conducted with different types of cryptocurrencies.

Simple Arbitrage (Cross-Exchange Arbitrage)

This type of arbitrage is more or less what was spelled out in our example above. It involves finding a price discrepancy between exchanges, buying from one, and selling to the other to attempt to generate a profit. While this is a simple tactic that can take advantage of price discrepancies, it may expose you to risks like transfer times and costs.

Spatial Arbitrage

Spatial arbitrage is very similar to simple arbitrage, but is distinct in that there are price differences between an asset trading in different geographic locations.

Triangular Arbitrage

Triangular arbitrage takes advantage of pricing inefficiencies among different pairs of cryptocurrencies, often on the same exchange. With this strategy, someone starts with one cryptocurrency and then sells it for another cryptocurrency — one which is undervalued relative to the other.

The participant would then transact that second cryptocurrency for a third cryptocurrency which is relatively overvalued when compared with the first. Finally, they would transact that third cryptocurrency for the first crypto, completing the circuit potentially a little richer.

Weighing the Opportunity: The Pros and Cons of Crypto Arbitrage

Crypto arbitrage has some pros and cons to be aware of.

The Appeal of Crypto Arbitrage

Crypto arbitrage can be an appealing strategy for a few key reasons. Notably, it’s a market-neutral strategy, meaning that it’s theoretically possible to make money regardless of overall market conditions. So, if the stock market is taking a downturn, that doesn’t mean you couldn’t potentially generate returns through crypto arbitrage.

Additionally, the crypto trading markets go non-stop, worldwide, and there are thousands of cryptocurrencies out there. That means there’s a potentially large number of opportunities for crypto arbitrage, if you can find them.

The Risks of Crypto Arbitrage

There are also significant risks you should take into account when engaging in crypto arbitrage. Perhaps most notably, price slippage, which means that the price discrepancy that you are attempting to exploit suddenly disappears, leaving someone “holding the bag,” so to speak, after they initially purchase the cryptocurrency.

There can also be delays and congestion on platforms, which can slow down transactions and potentially lead to price slippage. There are transaction fees to take into account, as well, and it may even be possible to break the rules of a given platform, meaning that your activity is frozen or put on hold.

Tax Implications of Arbitrage

Arbitrage can trigger tax liabilities.

In the U.S., where cryptocurrency adoption has skyrocketed in recent years, the IRS has created a tax guide which categorizes cryptocurrencies as property, like stocks, bonds, and other capital assets.

Entities that engage in arbitrage are required to pay capital gains taxes on cryptocurrency when selling, trading, or disposing of their holdings. (Additionally, cryptocurrencies can be taxed as income if an individual receives the crypto as a gift, from mining, or for services rendered.)

With that in mind, you must account for any capital gains taxes on their federal income tax return, but may also be able to take deductions based on any losses. Be aware that state taxes may also need to be reported, where applicable. You should also receive a form from your brokerage or trading platform to help you calculate your tax liabilities and fill out your tax return.^[1]

As always, it may be helpful to discuss with an accountant or financial professional.

Note, too, that cryptocurrency taxation rules are evolving, so it’s best to try and keep track of the latest changes to rules and regulations.

Why Every Arbitrage Transaction May Be a Taxable Event

Given that cryptocurrency is considered “property” in the U.S. for taxation purposes, each transaction will result in either a capital gain or loss. In the case of crypto arbitrage, gains from transactions would likely be taxed as short-term gains, which applies when a digital asset is held (as a capital asset) for one year or less. Short-term gains are taxed as ordinary income, which is typically higher than the rates for digital assets held for longer than a year.^[2]

In short, that’s why each arbitrage transaction triggers a taxable event: You’re generating a capital gain or loss with each transaction.

The Importance of Meticulous Record-Keeping

New rules are making it easier to keep track of your transactions through a brokerage or trading platform, along with capital gains or losses and respective tax liabilities. But it’s still a good idea to try and keep meticulous records, to ensure that you’re paying any applicable taxes that you owe.

Until recently, keeping track of your capital gains or losses on crypto holdings was entirely up to the individual, which is why it was so important. It’s still up to you to report your transactions correctly, as it’s possible that your platform or exchange could make a mistake.

A Note on Professional Advice

Again: It could be a good idea to ask an accountant or financial professional for help or to answer any questions you may have about your tax liabilities resulting from crypto trading activity. It can be confusing, and the laws and rules are in flux, so don’t be afraid to reach out.

Crypto Arbitrage Bots and Platforms

A couple of other things that you should know about: Arbitrage bots and platforms.

What Are Crypto Arbitrage Bots?

Why manually buy or sell when you could use bots to do it for you? That’s actually an option, as there are programs on the market that can identify arbitrage opportunities, and automatically execute purchases or sales on someone’s behalf. Of course, this requires some technical know-how and a fairly high risk tolerance, but these “bots” are more or less automated software sequences that are used by some to try to generate returns.

Popular Arbitrage Platforms and Scanners

There are numerous crypto trading platforms, services, and software on the market. Some incorporate trading bots directly into their platforms, too. Some examples of these include Pionex, Bitsgap, Cryptohopper, ArbitrageScanner, and 3Commas. It’s important to do your own research to figure out if any platform might work for your specific situation and strategy.

The Takeaway

Arbitrage exists across the capital markets, in stocks, bonds, and commodities, wherever the same asset buys or sells for different prices in different places. Since cryptocurrencies are digital and aren’t based on an underlying asset (with some exceptions, such as stablecoins), it is harder to place a value upon these currencies, and they don’t have the same pricing conventions as equities and bonds, which are tied to the performance of a company, municipality, or nation.

Cryptocurrency is complicated, and arbitrage strategies can be even more complex. But the practice is legal, and has the potential to yield rewards while also exposing a participant to high risk.

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FAQ

Is crypto arbitrage still profitable?

Crypto arbitrage can be profitable, but it also involves considerable risk. There’s no guarantee of a positive return.

How much money do you need to start crypto arbitrage?

It’s possible to attempt to profit from discrepancies in crypto prices with a relatively small amount of money, especially since many cryptocurrencies buy and sell for fractions of a cent. It’s important to remember that arbitrage is risky, however, so any amount of money put toward crypto arbitrage — big or small — could potentially be lost.

Is crypto arbitrage legal?

Yes, crypto arbitrage is legal in most regions so long as you’re doing it in a place where crypto trading is legal.

What is the fastest way to find crypto arbitrage opportunities?

Perhaps one of the quickest ways to find crypto arbitrage opportunities is to use a scanner or trading bot to flag those opportunities for you. Otherwise, it could take considerable time and effort to manually compare prices between exchanges and platforms.

Can you lose money with crypto arbitrage?

Yes, there is a high risk of losing money with crypto arbitrage, as prices are always in flux.

Can you make a living off of crypto arbitrage?

It theoretically may be possible to make a living off of crypto arbitrage, but it would likely be challenging to do, and it’s important to remember there are significant risks involved with crypto arbitrage, as well.

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The term “black swan event” is widely used in finance today to describe an unanticipated event that severely impacts the financial markets. The name stems from the discovery of avian black swans by Dutch explorer De Vlamingh while exploring Australia in the late 1600s. Historians credit de Vlamingh with separating the “expected” (i.e., a white swan, which were plentiful) with the “unexpected” (i.e., a black swan, which was a rare sighting).

Writer, professor and former Wall Street trader Nassim Nicholas Taleb popularized the financial theory of “black swan” events in his 2007 book The Black Swan: The Impact of the Highly Improbable. Taleb described the occasional, but highly problematic, arrival of black swans on the investment landscape, and outlined what, in his opinion, economists and investors could do to better understand those events and protect assets when they occur.

What Is a Black Swan Event?

According to Taleb, a black swan event is identifiable due to its extreme rarity and to its catastrophic potential damage to life and health, and to economies and markets. Taleb also notes in the book that once a black swan landed and devastated everything in its path, it was obvious in hindsight to recognize the event occurred.

This is how Taleb describes a black swan event in his book: “A black swan is an unpredictable event that is beyond what is normally expected of a situation and has potentially severe consequences,” Taleb wrote in his book. “Black swan events are characterized by their extreme rarity, their severe impact, and the widespread insistence they were obvious in hindsight.”

It can be a difficult concept for investors. Who, after all, throughout the history of the stock market, would leave their finances unprotected from a black swan onslaught if they knew the event was imminent?

By definition, predicting the arrival of a black swan is largely outside the realm of probability. All anyone needs to know, Taleb maintains, is that black swans occur and investors should not be surprised when they do happen.

Taleb outlines three indicators that signal the arrival of a black swan event. Each is meaningful in truly understanding a black swan scenario.

1.    Black swan events are outliers. No similar and prior event could predict the arrival of a particular black swan.

2.    Black swan events are severe, and typically inflict widespread damage. That damage also has a severe impact on economies, cultures, institutions, and on families and communities.

3.    They’re usually recognized in hindsight. When black swans occur and eventually dissipate, recriminations take its place. While the specific black swan event wasn’t predicted, observers say the event could have and should have been prevented.

💡 Quick Tip: All investments come with some degree of risk — and some are riskier than others. Before investing online, decide on your investment goals and how much risk you want to take.

Examples of Black Swan Events

It’s become common for politicians and investors to call any negative event a “black swan” event, whether or not it meets Taleb’s definition. However, history has no shortage of true black swan events, which led to large, unpredictable market corrections.

The following events are considered some of the most infamous among economists and historians.

The Soviet Union’s Historic Collapse

Economists consider the collapse of the Soviet Union in 1991 a major black swan. Only 10 years earlier, the Russian empire was considered a major global economic and military threat. A decade later, the Soviet Union was no more, significantly shifting the global geopolitical and economic stage.

The 9/11 Terrorist Attacks

In hindsight, the United States might have seen the attacks on the World Trade Center in New York City and the Pentagon in Washington, D.C. coming. International terrorism had long been a big risk management issue for the U.S. government, but the severity of the attack left the world stunned — and plunged the U.S. into a serious economic decline. Stocks lost $1.4 trillion in value the week after the attacks.

The Dot-com Bubble

In the late 1990s, investors were indulging in irrational exuberance and nowhere was that more clear than with the nation’s stock market — particularly with white-hot technology stocks. With an army of Internet stocks in the IPO pipeline, overvalued tech stocks plummeted, taking the entire stock market down in the process. The damage was staggering, with the Nasdaq Index losing 78% of its value between March 2000 and October 2002.

The 2008-2009 Financial Crisis

After a series of high-risk derivative bets by major banks, mounting losses in the U.S. mortgage market, and the collapse of Lehman Brothers, the U.S. economy teetered on the edge of disaster — a scenario it would take almost a decade to correct. The unemployment rate doubled to more than 10%, domestic product declined 4.3%, and at its worst point, the S&P 500 plummeted 57%, creating a bear market.

It’s worth noting that although some people have referred to the Covid-19 pandemic as a black swan event, Taleb does not consider it to be one since he feels there was enough historical precedence to foresee it.

Why Do Black Swan Events Happen?

Since black swan events are virtually impossible to predict, there is no concrete answer as to why they happen. The world is complicated, with many different factors — political, financial, environmental, and social, among others — impacting one another and setting off chains of events that could potentially become black swan events in scope and magnitude.

Can You Predict a Black Swan Event?

By its very definition, it’s nearly impossible to predict a specific black swan event. This makes it hard to prepare for black swans as you would for other investment risks.

Instead, investors may want to focus on making sure they’re prepared, generally, for the unknown. Here’s how to help do that:

•   Try to develop a pragmatic mindset. Investors are better off knowing unanticipated negative events do exist and could arrive on their doorstep at any time. Keep in mind the possibility of black swans and consider building an expectation of stock volatility into your overall portfolio-management strategy.

•   Try to avoid getting bogged down by long-term forecasts. Relying solely on expert predictions or far-off investment outlooks can be overwhelming, since unexpected events, including black swans can happen at any time and it’s normal for markets to fluctuate. Instead, some investors consider building a more conservative element into your investment portfolio, one that relies more on protecting your assets, so you’re not tempted to make rash moves during a black swan event. Have a candid conversation with your financial advisor, or educate yourself if you don’t have a financial advisor, about how proper diversification may help build a portfolio that balances the need for performance with the need for protection.

•   Don’t panic when a black swan event happens. As tempting as it might be to try to get out of a market during a black swan event and get back in when it fades away, resist the urge to engage in market timing.

•   Many investors try looking for opportunities. Putting money into the markets during a black swan event can be difficult and potentially risky, but investing in a down market may yield positive returns over the long-term.

Rather than trying to time the market, some investors may consider using a dollar-cost averaging strategy, when making regular purchases — even during a black swan event.

The Takeaway

For long-term investors, the prudent stance on black swan events is to acknowledge their existence, build some protection into your investment portfolio to help mitigate potential damage, and be ready to take full advantage of a market upturn once the black swan flies away.

Ready to invest in your goals? It’s easy to get started when you open an investment account with SoFi Invest. You can invest in stocks, exchange-traded funds (ETFs), mutual funds, alternative funds, and more. SoFi doesn’t charge commissions, but other fees apply (full fee disclosure here).

FAQ

What is a black swan event in recent years?

One of the most recent black swan events was the 2008-2009 financial crisis known as the Great Recession. That’s when a series of high-risk derivative bets by major banks, mounting losses in the U.S. mortgage market, and the collapse of Lehman Brothers, the biggest U.S. bankruptcy ever, pushed the U.S. economy to the edge of disaster.

What was the biggest black swan event?

The Great Depression of 1929 was probably the most infamous black swan event. It started with the U.S. stock market crash in October 1929 and led to a worldwide drop in stock prices. The U.S. economy shrank by 36% between 1929 and 1933, many banks failed, and the U.S. unemployment rate skyrocketed to more than 25%. It was the longest and most severe economic recession in modern history.

What are the attributes that identify a black swan event?

According to Nassim Nicholas Taleb, who popularized the black swan theory, the attributes that identify a black swan event are: 1) black swan events are rare and no similar or prior event could predict them, 2) black swan events are severe and inflict widespread damage, and 3) after the fact, observers say the black swan event could have and should have been prevented.

Photo credit: iStock/by Martin Nancekievill