Crypto arbitrage simply explained

Coindirect has created a ‘closed loop’ arbitrage to remove most of the risks.
Coindirect was founded in SA but has since relocated its head office to London. Image: Chris Ratcliffe/Bloomberg

Tens of thousands of South Africans have become familiar with crypto arbitrage in the last few years, but for far more people it remains a mystery.

This Q&A with Chris Harmse of Coindirect answers the key questions surrounding crypto arbitrage.

What is meant by arbitrage?

It is the simultaneous buying and selling of the same asset on different markets. For example, bitcoin may be trading at R500 000 overseas, and at R520 000 in SA. You can grab that R20 000 profit by buying bitcoin on the cheaper market in the UK and shipping it to SA (which takes about 45 to 60 minutes) and selling it at the higher price.

That R20 000 profit works out to be a 4% profit on the full bitcoin price of R500 000. You don’t need R500 000 to participate in crypto arbitrage, though the minimum recommended capital is R100 000. Less than that, your profit gets reduced by the costs involved.

What are the risks of arbitrage?

The whole idea of arbitrage is to remove as much risk as possible. If you buy and hold bitcoin, that is risky. You are betting on the bitcoin price continuing to appreciate in price, when history tells us that the bitcoin price is extremely volatile – as we have seen in the last two months, given the nearly 50% drop in price over that time period.

This is what we call market risk. In a traditional arbitrage situation, you would also have forex risk: you have to purchase forex and ship to our overseas crypto wallet – that can take a few hours, during which time the exchange rate can move against you and eat into your expected profit. Then you would purchase bitcoin overseas and ship it back to SA, during which time the bitcoin price can move against you.

At Coindirect, we have access to forex and crypto liquidity through a combination of our own balance sheet and a deep network of liquidity providers. This means we can eliminate the forex and market risks. When the arbitrage trade is executed, we immediately credit the client with the amount of forex they have purchased. We also immediately purchase bitcoin on the cheaper market (in the UK) and simultaneously sell that in SA to lock in the profit.

The word arbitrage itself comes from the same root as ‘arbitrate’, meaning to give judgement. An arbitrage trade is an attempt to remove risk (or judgement). We buy bitcoin cheaply in one market and sell it at a higher price in another. The idea is to remove risk as far as possible.

There are, of course, other risks, such as the risk that the exchanges conducting the arbitrage trade will fail, which is why you need to stick with well-capitalised and reputable platforms, such as Coindirect.

The arbitrage premium between overseas and local exchanges has been very low this last month. To date, Coindirect has never had a single trade lose money.

So Coindirect’s arbitrage trade is fully hedged?

Yes, we hedge our clients’ position using our own balance sheet. In effect, what happens is we credit the client’s account with the initial rand capital plus net profit bitcoin within a matter of minutes – rather than the hours it would take doing arbitrage the normal way. Your profit (plus your capital) on each trade is visible in your account within minutes.

Is the crypto arbitrage market disappearing because too many people are taking advantage of it? 

The growing number of participants in the crypto arbitrage market certainly accounts for the smaller arbitrage premium, which is currently about 1% to 2%, but this is something that we have seen before. At other times during this year we have seen the premium at 4% to 5%. The arbitrage premium may be low now, but it will widen again, as it has done in the past.

What causes bitcoin to trade at different prices in different markets?

There is no centralised exchange for crypto assets. Each crypto exchange creates its own market, so the price of bitcoin may vary on one exchange relative to another. There are people who monitor these price differences all the time and look for opportunities to profit from it.

What drives the price of any asset is supply and demand. A rush of demand accompanied by a shortage of supply will cause the price to rise on one exchange, while on another the price remains relatively unaffected.

The arbitrage market will never completely disappear. Any country with foreign exchange controls, like SA, is going to have a shortage of hard currencies like the US dollar. For the same reason, we pay a slightly higher price for internationally traded assets like bitcoin.

We have seen the arbitrage premium widen when the price of bitcoin has been rising and thousands of new people enter the market. And we’ve seen the arbitrage premium drop to virtually zero or even negative (meaning it is cheaper to buy bitcoin in SA than overseas). The more usual position is that it is cheaper to buy bitcoin abroad than in SA. So long as this situation prevails, there will be arbitrage opportunities.

Are there other types of arbitrage?

Yes. You get arbitrage opportunities between different exchanges, even within SA. You get geographical arbitrage between different countries – which is very much what Coindirect is doing.

Can clients select their desired minimum profit range?

Yes, though sometimes picking the highest tier isn’t recommended if you are trying to maximise your offshore allowance or if you want your capital back faster. Obviously the profit target range must be realistic. If you choose a net profit of over 2% you will most likely go through some periods where no trades are executed. But if the client wants a 1.5% net profit after all costs have been deducted, we will only execute on trades that will deliver that target – and this is a huge comfort to clients.

We currently offer three net profit target ranges:

  • 1% to 1.5% (recommended)
  • 5% to 2% (majority of clients)
  • 2% + (slow execution).

What are the costs of the Coindirect arbitrage?

Clients need a minimum of R100 000 to take advantage of the service, and Coindirect charges 1% of the capital on each arbitrage trade. That does not include the R500 Swift fee plus 0.35% for forex handling, making a total of 1.85%.

Who is behind Coindirect, and how solid is its balance sheet?

Coindirect was founded in SA, but it has since relocated its head office to London and now has offices in the UK, SA, New York and Hong Kong. Coindirect recently raised €1 million (R17 million) in a seed funding round led by Concentric, with participation from Blockchain.com and Andreessen Horowitz-backed MakerDAO. However, it is able to offer deep liquidity through arrangements with outside liquidity providers. What this means is that it can handle large volumes of trades at any time.

To register for Coindirect’s arbitrage service, sign up here.

Brought to you by Coindirect.

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