Hi everyone!
A few days ago, I was asked by another publication why bitcoin seemed so much less volatile these days, and as soon as I sent in my answer, the price fell by almost 8 percent within a few hours. That’s one of the things I most love about this sector – there is no place for complacency.
As many of you in the U.S. head off for the long weekend, it’s worth reflecting on why you are interested. Where do you think it’s going? Why do you want to find out more? And how can we help you do that? Drop me a line and let me know.
In THE BRIEFING this week, my colleague Galen Moore goes deep into the May 17 flash crash, and shows how the crypto market's fragmented and decentralized structure can make it more vulnerable to manipulation – ironic, since decentralization in other applications can add resilience.
As usual, there are a ton of useful and interesting links below, including one to our new daily podcast series: CoinDesk Markets Daily. You can subscribe to it on your usual platform, or listen to it on coindesk.com.
Read on…
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THE MECHANICS OF MARKET MANIPULATION
The levers are there to move hundreds of millions in crypto markets, and they're clearly labeled
On May 17 of this year, bitcoin's price dropped suddenly. The action started on a single exchange: Bitstamp, domiciled in Luxembourg, where the dollar price of bitcoin suddenly dropped more than 18 percent in a matter of minutes. The CoinDesk Bitcoin Price Index, a composite of several market feeds, recorded a 6 percent drop as a result.
Bitstamp was, at the time, one of three spot markets used as equal components in the bitcoin price index for BitMEX, a crypto derivatives exchange domiciled in the Seychelles that operates one of the most liquid bitcoin derivatives markets, the XBT/USD perpetual swap. BitMEX's other two bitcoin index components are Coinbase Pro and Kraken. Of the three, BitStamp's reported volumes are lowest.
The BitStamp price drop wasn't random. It was caused by a large bitcoin sell order, placed well below the market. The resulting downward pressure triggered auto-liquidations of long positions in the hundreds of millions of dollars on BitMEX.
Traders with short positions on the exchange stood to benefit.
In this column, I'll provide a visual blow-by-blow of what happened May 17 on BitStamp, and a risk/return estimate: if it was manipulation, how much it cost, and how much the manipulators earned. I'll conclude with thoughts on the liquidity imbalance that caused it, and how it might happen again.
Before getting into that, I'll explain briefly how novel structures and thin markets could make such manipulation possible.
Novel market structures
In crypto markets, it's normal for investors to interact directly with the exchange – an ethos derived from bitcoin, which invites its users to transact pseudonymously, without intermediaries. On derivatives exchanges, accommodating this requires a rethinking of market structure.
On traditional derivatives exchanges, brokers and clearinghouses manage the risk that a large price move will bankrupt one side of a trade. All participants have an incentive to make good at settlement, so they can trade again tomorrow. On the largest crypto derivatives exchanges, it is possible to trade directly under one account today and another tomorrow. This unfettered access and pseudonymity is part of the story of these exchanges' rise to become the most liquid markets in crypto.
To cover settlement risk, BitMEX and other large crypto derivatives exchange operators use auto-liquidiation. For example, if the index price drops far enough below an open long position, the exchange automatically liquidates that position, to settle the trade. Excess proceeds from auto-liquidations are stored in an insurance fund. If auto-liquidation falls short of settlement, the insurance fund kicks in. If the insurance fund's earmark falls short, auto-deleveraging occurs, unwinding both sides of the trade.
Thin markets
Liquidity is a subjective term, meaning an investor's ability to move a reasonable volume of an asset, without an undue price shift. It is related to market depth, measured by the worst price an order will hit at a certain size limit.
In crypto, market depth is fragmented among dozens of the largest exchanges, and hundreds more in the long tail. Even in crypto's blue-chip assets, bitcoin and ether, pools of liquidity are scattered, which makes them more shallow. This situation may be worsening. Bitcoin's bid-ask spreads have widened on most of the largest exchanges in 2019, indicating decreasing market depth according to one tracker of composite data.
Exchanges that are part of price discovery infrastructure are thin enough that a large-ish order will move the price. And, as we will see below, derivatives markets can be far more liquid than the spot exchanges that help determine the price of their underlying assets.
What happened May 17
The chart above presents a second-by-second account of what happened on the Bitstamp BTC/USD spot market in the early morning hours of May 17, UTC. Each point on the chart is the minimum, or best, ask price offered in each minute's snapshot of orderbook data, which is provided by CoinRoutes. The size of the point indicates the quantity of the order.
The action began at 3am UTC, with a sell order roughly 6 percent below the market price and hundreds of times larger than the norm on the exchange at that time. As that order fulfilled available bids, the ask price moved lower, dragging the market price down until it reached $6,276, at which point the selling stopped. A chronological calculation shows the sellers sold about 2,905.7 units of bitcoin, in aggregate at about $2.5 million below what they would have realized at a bitcoin market price of $7,700. At the same time, over $200 million in long positions were being liquidated on BitMEX, according to skew.com . If it was manipulation, it returned up to an 80X multiple over what the manipulators put at risk. The whole thing was over in about 10 minutes.
Conclusions
Bitcoin's network security model is a fairly straightforward bit of rational choice theory: miners are rewarded for recording new transactions. To earn the reward, they must prove they have committed something of value, i.e., energy. If a miner attempts to manipulate the transaction record, other miners will likely reject the contribution, invalidating the reward. The cost of manipulation and the likelihood of failure is balanced against the reward for expected behavior.
Bitcoin programmatically maintains that balance, without recourse to identity verification or trusted third parties. However, the market structure that has evolved around bitcoin has so far failed to achieve a similar equilibrium.
Not that folks haven't tried to patch the problem: BitMEX revised its bitcoin price index components in November, adding two new spot markets; Deribit, which at this writing operates the largest bitcoin options exchange, domiciled in the Netherlands, has promoted a different way of handling liquidations . As long as deep pools of liquidity remain dependent on shallow pools, bitcoin's market structure will be out of balance – and manipulators will have incentives to find ways around these patches.
– Galen Moore
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* it's a short week for U.S. readers, so I've starred six especially important pieces in case you need to put down the screen sooner than usual
BIG IDEAS
Bring Out Your Dead! (Arca) – Jeff Dorman reminds us that innovation impact is very hard to see while it’s happening, and that it’s safest to bet on a directional rather than a specific change.
History Doesn’t Repeat Itself, But It Does Rhyme (AVC) – Comparing the evolution of the crypto sector with that of the internet, venture capitalist Fred Wilson posits that crypto’s “killer app” could emerge 2021-22.
Our decentralised future? A blockchain primer (David Kelnar) – A sweeping and well-written introduction or summary (depending on where you are in the learning curve) to blockchain’s potential and its hurdles.
The Case for a Bitcoin ETF (CoinDesk) – Dave Weisberger of CoinRoutes believes that the SEC, in denying bitcoin ETFs, is putting subjective judgement before fair market principles.
Willy Woo pointed out that holding bitcoin is “using” bitcoin, because its use as a potential store of value takes advantage of its unique characteristics.
MARKETS
*Institutional Market Insights, 2nd edition (Binance) – A survey of 76 institutional investors, managing crypto holdings of between $100,000 and $25 million, which revealed some unexpected findings: for instance, the largest risks for the sector are platform-specific issues and tether’s ongoing legal issues.
Crypto isn't going to see exchange consolidation for 2 reasons, according to trading exec (The Block) – One is that most crypto exchanges accumulated strong war-chests in the 2017 boom; another is the captive user bases.
HODLers Are ‘In the Money’ Despite Bitcoin’s Drop to Six-Month Lows (CoinDesk) – According to blockchain intelligence firm IntoTheBlock, over 50% of bitcoin holders have accumulated profits even at current prices.
A look at CFTC-regulated, and self-reported bitcoin derivative data: hedge-funds at an all time high in CFTC net short position this month (The Block, paywall) – CME derivatives data shows that contracts are contracting and going negative.
What a Schwab-TD Ameritrade Merger Would Mean for Crypto (CoinDesk) – TD Ameritrade has been involved in crypto markets for some time now, but Schwab has notably stayed away; will the acquisition change TD Ameritrade’s strategy?
Fidelity Digital Assets to Sign Up Its First Crypto Exchange by End of the Year (CoinDesk) – So far, the platform has been working with OTC desks, but would like to broaden its pool of liquidity providers.
Singapore Proposes Allowing Bitcoin, Ether Derivatives Trading on Approved Exchanges (CoinDesk) – The region’s financial regulator has published a consultation paper that proposes allowing crypto derivatives to be traded on regulated platforms, in response to demand from international institutional investors.
NEW PRODUCTS
Bakkt’s Bitcoin Futures Launch in Singapore in Just Two Weeks (CoinDesk) – The cash-settled monthly bitcoin futures will be available globally to all ICE customers.
Galaxy Digital takes another swing at crypto asset management, but the landscape is more competitive than ever (The Block) – The crypto firm is launching the Galaxy Bitcoin Fund and the Galaxy Institutional Bitcoin Fund, targeting accredited investors between the age of 50 and 80 who have not yet actively invested in crypto assets.
Silvergate Bank CEO Bets on Higher Crypto Price Volatility After $40M IPO (CoinDesk) – The bank is using part of its recent listing proceeds to develop new services, including lending.
The Surprising Reason Why Blockstack May File for an IPO (CoinDesk) – It’s to do with the legal framework for mining “securities.”
Now Publicly Quoted: Grayscale’s Diversified Investment Product (Grayscale) – The Grayscale Digital Large Cap Fund is now publicly quoted on the OTCQX market under the symbol GDLCF, making it the first multi-asset publicly traded crypto fund in the U.S.
Crypto OTC Traders Could Have an AI Chatbot Working for Them Come December (CoinDesk) – A chatbot from London-based trading startup Artificial Intelligence Exchange, when launched in December, could automate pre- and post-trade administration, assist in negotiations, perform pre-trade credit checks and pass trade details electronically to a settlement agency or clearinghouse.
MVIS and CryptoCompare have launched the MVIS CryptoCompare Institutional Bitcoin Index (MVIBTC), which will be used by 3iQ for the purpose of NAV calculation of its Bitcoin Trust.
PROFILES
Inside B2C2: The crypto market making firm that almost closed shop in 2018, and is now growing market share across the globe (The Block, paywall) – Insight into the size of the OTC market, electronic trading and the importance of a global approach.
CRUNCHING NUMBERS
*The Bitcoin Drop Explained in Seven Fascinating Blockchain Analytics (IntoTheBlock) – Looking at blockchain data can tell so many stories.
How Many Bitcoins Are Permanently Lost? (CoinMetrics) – An in-depth calculation of what bitcoin’s hard cap is in reality, as opposed to in theory.
REGULATORS AT WORK
Stephen Palley worries that the BSA and FinCEN are, have been and will remain the 10,000 pound elephant for crypto for the next 2 to 3 years.
South Korea Takes Legal Step to Stamp Out Unregistered Crypto Exchanges (CoinDesk) – Heads of cryptocurrency exchanges that fail to register with South Korea's top financial regulator may soon face jail time.
Another Class Lawsuit Claims Bitfinex, Tether Manipulated Bitcoin Market (CoinDesk) – This is the second class action to have been brought in recent months, and alleges that Bitfinex and Tether "monopolized and conspired to monopolize the Bitcoin market."
STABLECOINS
*Privacy and Cryptocurrency, Part IV: Stablecoins— Blacklists and Traceability (Human Rights Foundation) – The opportunities in and risks of using stablecoins in certain areas of the world.
For a TL;DR, Eric Wall tweeted a thread that summarizes part of the above, also worth a read.
Too Early to Tell if Libra Is a Security, CFTC Chairman Says (CoinDesk) – Chairman Heath Tarbert believes that the Facebook-proposed stablecoin is too early in its development to determine what type of an asset it will become, if launched.
What Does a Crypto OTC Desk Do with Stablecoins Like USDC? (Circle) – How stablecoins facilitate liquidity in the ecosystem.
SECURITY TOKENS
Tokenized Real Estate Falters as Another Hyped Deal Falls Apart (CoinDesk) – The noise around the potential of security tokens to improve the liquidity and efficiency of real estate investments masked a lack of institutional interest.
Franklin Templeton Taps Wallet Service Provider to Support Tokenized Shares (CoinDesk) – Wallet service provider Curv will help safeguard the money market fund shares that the global investment firm is planning to launch on the Stellar blockchain.
Polymath Moves Security Token Platform Off Ethereum and Onto Parity’s Substrate (CoinDesk) – The security token issuer has migrated its Polymesh blockchain onto Substrate, the platform developed by Parity Technologies.
PODCASTS
COINDESK MARKETS DAILY: We’ve launched our own daily podcast series! Hosted by Adam B. Levine and Brad Keoun, it will talk about recent market events and sector developments.
*ON THE BRINK: Nic Carter and Matt Walsh talk to investor John Pfeffer about crypto as an asset class, valuation methods, portfolio construction and more.
ON THE BRINK: The Castle Island Ventures team also talk to Ash Egan, partner at Accomplice, about utility tokens, ethereum killers, information disclosures and more.
THE SCOOP: Frank Chaparro chats to Max Boonen, founder of B2C2, about the origins and current state of OTC crypto markets, the role of tether, and more.
*OFF THE CHAIN: Anthony Pompliano talks to Tom Lee, managing partner and head of research at Fundstrat Global Advisors, about shifts in our understanding of money, the role of automation, our perception of value and what that can mean for the crypto sector.
CHAIN REACTION: Tom Shaughnessy talks to Digital Assets Data’s Mike Alfred about the hurdles to blockchain analytics, business building and marathons.
CHAIN REACTION: Tom Shaughnessy interviews Matthew Finlayson, co-founder of Invictus Capital, on the role of tokenized funds and financial inclusion.
CRYPTO CONVERSATION: Andy Pickering chats to Danny Kim, head of growth at SFOX, about crypto liquidity, market infrastructure and institutional involvement.
STATE OF CRYPTO: The Amun crew talk about whether bitcoin’s potential benefits outweigh its energy consumption cost.
VENTURE COINIST: Luke Martin talks to Dovey Wan of Primitive Ventures (and member of CoinDesk’s Advisory Board) about the evolving China narrative.
A-HA!
*Vitalik Buterin - The Ethereal Prince and His Virtual Machine (The Portal, podcast) – A characteristically deep and long conversation between host Eric Weinstein and Vitalik Buterin, the creator of ethereum.
Global Protests Reveal Bitcoin’s Limitations (CoinDesk) – Leigh Cuen spoke to bitcoin users in Hong Kong, Lebanon and Iran about how hard it is for the disenfranchised and those living in conflict zones to actually use bitcoin.
Winners of the Red Bull Illume Photo Contest 2019 (The Atlantic) – Gorgeous photos, some of which made me feel the need to sit down.
My Five Favorite Novels with Economics Themes (The Library of Economics and Liberty) – There’s a long weekend coming up.
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FIRMS
Binance, the largest crypto exchange in the world by volume, has made a move into India's potentially huge, but troubled, cryptocurrency market with the acquisition of the WazirX exchange platform.
New York-based crypto exchange Gemini has acquired Nifty Gateway, a platform for non-fungible tokens.
Coinbase UK now supports XTZ, DAI, EOS and LINK.
Have a tip? Drop me a line at [email protected]. |
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CRYPTO WEBINARS
Crypto podcasts have long been a staple of market education (see links above, for example), but I’ve noticed that there is a growing stable of informative webinars out there that don’t get enough air time in my opinion.
Here you have the crypto market webinars that I know about and that I think you might find interesting. If you’d like your webinar listed here, let me know at [email protected] (no guarantee of inclusion, though).
Crypto Market Data 101 – Nomics – Every weekday, 3pm ET
Patterns, Predictions and Fascinating Metrics from Cryptocurrency Order Books – IntoTheBlock – December 11, 2019, 12pmET.
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