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How to Analyze and Manage Risks in Arbitrage Trading
What are the risks associated with exchanges?
Important: Unknown exchanges can be dangerous. First, check reviews about the exchange and test with small amounts because there is always a risk of encountering scammers and losing money.
To engage in arbitrage, you need to find a leading exchange with good volume and a lagging exchange with likely smaller trading volumes and a price that lags behind the major exchange. There can be issues with the lagging exchange, such as withdrawals being closed for a couple of months or the exchange verifying only citizens of one country, which is often the case with Asian exchanges. Always check everything first through a search engine and then with small amounts. Be cautious in everything.
Important nuance: If your coin is listed on an exchange with high trading volume, like Binance, it doesn’t mean that the pair is only possible in the format Binance + small exchange. I have had many pairs in the format “small + even smaller exchange.” This also works, and the spread can hold longer.
So, it’s worth arbitraging not only with 2 exchanges but with a larger number.
What are the risks associated with exchanges:
Risk of a fraudulent exchange
There are many crypto exchanges, they are constantly being created, and among such exchanges, there are both normal and scam ones.
Always check information about the exchange. See if there are reviews on YouTube and in articles, check reviews, and see if people are writing about this exchange on crypto forums. If there are problems with the exchange, it has probably already been written about.
Treat reviews and overviews critically. Everything can be bought, exchanges can inflate reviews, and overviews can be purchased. So, learn to filter information.
Also, don’t pay much attention to the rating in reviews. Even Binance often has 2-3 stars, but it is the top exchange in the world. Usually, reviews are written only when something negative happens, so read what exactly happened. If you see many reviews saying the exchange doesn’t process withdrawals, blacklist the exchange immediately. This is a high risk for your balance. In the worst case, test with a small amount of $1-3.
It’s important that the same problem is repeated in negative reviews. If the exchange is 2-3 years old and you find 1-2 reviews saying they didn’t process withdrawals or stole money, it doesn’t mean it’s true. Keep in mind that there are many beginners in crypto who make the most basic mistakes, like sending from the ERC20 network to a wallet in the TRC20 network, and then writing that the exchange is a scam and stole their money. There are many such people, so be critical of everything and make your own decisions, not fully relying on others’ opinions. Also, if you decide to use an exchange, test everything with small amounts.
Another small tip: if you find a new exchange with no information about it, besides studying the exchange’s website, white paper, documents, etc., you can simply check the domain registration date. If the exchange claims to have been operating for 5 years, but you see the domain was registered this month, it’s likely a scam, and it’s better not to risk it.
Also, check the exchange’s terms of service. If they seem strange, it’s likely a scam. For example, I recently found a no-name exchange where you could buy TRX 12% cheaper on the swap than on the spot, but the minimum swap amount was $400. With a 99% probability, this is a scam exchange that simply won’t process withdrawals, and they set such a limit specifically so that people deposit at least $400, not small amounts of $5-10.
By the way, this exchange’s condition about the minimum swap amount was hidden; it wasn’t mentioned anywhere initially. But I only lost $1 on it because I first topped up the balance for testing with the minimum amount.
Do the same if you find a new exchange. First, deposit a small amount and test how everything works, how quickly withdrawals are processed, and if they are processed at all. Always check the minimum deposit amount; it exists on all exchanges.
There is a lot of scam in crypto, so always be vigilant in everything.
Risk of being unable to withdraw from an exchange
There is also a risk that you may find a legitimate exchange, but it has conditions that prevent you from withdrawing money. For example, it could be a Chinese exchange that only works with Chinese citizens, and you simply won’t be able to pass KYC, meaning your money could get stuck on that exchange (always complete verification).
Always check the conditions on the exchange and test it first with a small amount. If everything is okay, then you can deposit the rest of your money. Otherwise, you risk losing everything you deposit on the exchange. It’s better to lose a couple of bucks on fees and testing than everything.
Also, check if the coins you are arbitraging have a withdrawal function on the exchange. Sometimes the spread is 10-20%, but the coin will be stuck with a “technical work” status for two months without the possibility of withdrawal. This means your capital is frozen for an indefinite period, while you could earn much more on arbitrage during that month.
Risk of very high withdrawal fees
Always check withdrawal fees. Many small exchanges are guilty of this. You can deposit Bitcoin without a fee, but for withdrawing Bitcoin, you will pay 0.01 BTC ($150-200).
If you get stuck in such a situation, look for other ways to withdraw from the exchange. Usually, stablecoins have relatively small fees on any exchange, as well as cheap coins like DOGE, LTC, DASH. You can arbitrage with another exchange to break even and exit the exchange with stablecoins or other crypto.
Risk of inflated volumes
This risk won’t harm your balance directly, but you will lose time. Many exchanges offer a service to inflate volumes for coins, so you might see a 5% spread in the order book and seemingly constant trades, but when you place a buy order, no one will sell to you, even if you set it at the price of the last trades. This is due to bots trading among themselves, but they will ignore your orders.
Such bots can be identified by the trade history: firstly, they often have orders of the same size or just follow one another, and secondly, they trade outside the order book, i.e., there are buy and sell prices, but all trades occur at the average price.
A clear example is the Yobit exchange. Trading volume is 3000 BTC, with completed orders of 74 and 159 ETH. And in the order book, the volume to change by 1% is no more than a couple of ETH.
Here’s an example of bots that inflate volumes. Because of them, it seems like trading is active, but in reality, your order might hang for an hour while trades continue within the range between buying and selling.
If you encounter this – bots are not perfect and can be used to make a trade. It’s simple: you look at the trade history and set the price of the last order if it suits you. There’s a good chance the bot won’t react in time and will make a trade with you, or it’s just set to trade within that range, and you can work with it comfortably.
So, don’t be afraid of bot volumes and try to use them to your advantage. I’ve made good money on this trick. This way, you can sell coins not to the order book but to bots. As a result, if the rate doesn’t change significantly, you can turn over a volume 10 times larger than if you were selling to the order book. There won’t be a drop in the rate either.
A similar risk exists with various crypto exchangers and Telegram bots. Always check everything carefully, make sure the address of the exchanger/bot is correct, as there is a chance it could be phishing. Check reviews and exercise maximum caution everywhere.
Another big tip: if you come across an exchange with no information available online, look up data about it on the internet. You can check the domain registration date and page traffic; this information will give you more insight into the exchange.
Search for “domain age online” and check through any of the sites. For traffic, do the same, either search through a search engine or install an extension.
If the domain is a couple of months old – it’s a huge risk. The likelihood that this is a scam exchange/exchanger is very high.
If the traffic is 1-2k people or less, it’s also a risk. But traffic in general is not an indicator; it can be inflated, and the site may still be new. Nevertheless, low site traffic is a risk.
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