Dear Early Investor,
This week’s questions cover two interesting topics we spotted in the Early Investing Mailbag: arbitrage and Coinbase. If you have any questions you’d like us to answer, please email us at firstname.lastname@example.org. Just remember, we can only answer your general questions for information and strategy. We can’t offer personal advice.
Q: What is arbitrage?
A: Arbitrage isn’t confined to the crypto world. It can be practiced wherever there’s a disconnect between markets offering the same asset.
I looked up Investopedia’s definition. It’s pretty good.
Arbitrage is the simultaneous purchase and sale of an asset to profit from an imbalance in the price. It is a trade that profits by exploiting the price differences of identical or similar financial instruments on different markets or in different forms. Arbitrage exists as a result of market inefficiencies and would therefore not exist if all markets were perfectly efficient.
As for cryptocurrencies, arbitrage opportunities arise from the crypto market being global… but not globally uniform.
The rules governing crypto and crypto exchanges vary from country to country. So do local supply and demand, capital control regulations and other government restrictions. The different strengths and inflation rates of local fiat currencies also give rise to divergent prices.
As a result, the price of cryptocurrencies can vary from place to place. What’s more, some exchanges develop reputations for offering unusually high or low buying or selling prices.
That represents a clear moneymaking opportunity. Here’s how it works…
You go to an exchange that has a reputation for lower-than-usual purchase prices. And you buy, say, $100 worth of bitcoin. Then you go to an exchange that has a reputation for higher-than-usual selling prices. And you sell your $100 worth of bitcoin for $130. For each transaction, you’ve paid a fee of, say, $5. You net profit is $20, or 20% of your original $100 stake.
Now, instead of $100, imagine you did this with a $5,000 stake. You’ve just made $1,000. And let’s say you turn around and put that $1,000 to work. So, next time you arbitrage, your stake is $6,000. The following time $7,200. Next: about $8,600. One more round and you’ve passed $10,000, doubling your $5,000 stake.
You cannot only arbitrage crypto, but also gold, crude, other commodities and even public stocks. But nowadays, crypto seems to be particularly susceptible to arbitrage opportunities.
- Early Investing Co-Founder Andy Gordon
Q: I read that some people have filed complaints with the SEC about Coinbase. Is this anything I should be worried about?
A: In a little more than five years, Coinbase has grown to 20 million-plus customers. Late last year, it was adding an estimated 50,000 new customer accounts a day.
This kind of growth is incredibly rare. Unfortunately, the experience was incredibly frustrating for many of its customers. Coinbase didn’t have enough trained (and trusted) customer service agents. Its software systems were overwhelmed at times. And there were problems with money transfers from banks.
News outlet Mashable has dug up a number of complaints about Coinbase that were filed with the SEC, and what’s there ain’t pretty. Here’s one excerpt:
Another individual claims that Coinbase has “stolen” a “majority of [their] life savings, and despite dozens of attempts to get in touch with someone at the exchange, they have only received form emails in response.
The first problem here should be obvious – “majority of their life savings.” No one should invest a majority of their life savings in cryptocurrency. We recommend our members invest only a small portion (1% to 5%) of their overall investment portfolio.
Still, I’m sure Coinbase didn’t handle all of these customer issues as well as it should have. As a group, cryptocurrency exchanges need to work on improving customer service.
But Coinbase simply didn’t have the manpower. It was adding 50,000 new accounts per day. That’s an outrageous number. It probably should have stopped accepting new customers, as competing exchanges Bittrex and Binance did. But for most customers, the system worked. So it decided to continue allowing new accounts. Whether this was the correct decision remains to be seen, but it’s the one it made.
When you’re adding more than a million new customers per month, errors, oversights and mistakes are bound to happen. Coinbase now has to deal with the bad PR, lost customers and other repercussions. I still believe Coinbase is one of the best crypto exchanges in the world. I believe it’ll weather this storm. This market correction has given it the opportunity to staff up and upgrade its systems.
- Early Investing Co-Founder Adam Sharp