More Evidence That Wall Streets Coming to Bitcoin

We wrote the other day that Wall Street and its vast capital is headed towards the crypto space. More evidence piles up daily, but I found one that was prescient.

ReformedBroker.com posted a note on his blog explaining how and why he purchased his first Bitcoin. I’d summarize it as “Bitcoin doesn’t seem to be going away so I best try it out.” He doesn’t offer much insight or new perspective, just seems to be capitulating and accepting that there just could be a future in cryptocurrency.

This guy is a financial advisor with a large blog following. This is how he describes himself:

I’m a New York City-based financial advisor and the CEO of Ritholtz Wealth Management.

We help people align their investments with their financial goals and manage portfolios for them. Our clients range from high net worth households to corporations to retirement plans to charitable foundations. For younger investors and those just getting started, we’ve created the Liftoff automated advisor – a simple, low-cost way to access a professionally managed portfolio selected just for you.

I am also the author of the books Backstage Wall Street and Clash of the Financial Pundits from publisher McGraw-Hill.  In addition, I serve on the advisory board of financial technology firm Riskalyze as well as CNBC’s Financial Advisor Council.

In 2015, I was named to the Investment News “40 Under 40” list of top financial advisors.

Here is the full article, from Reformed Broker:

So you are now free to dump all of your crypto-currencies because this surely marks an all-time top.

But I thought I’d mention it anyway.

For those who are curious about why and how, I’ll just say the following…

I’m old enough to realize that just because I don’t see a use for something, that doesn’t mean I won’t be proven wrong by others who do. At the current moment, I don’t see the financial industry use for Bitcoin other than some marginal activities like settling commodity trades that are very far divorced from my day to day existence. I understand the benefits of these things – the blockchain acting as verification that the counterparty has made payment instantly, etc. I’ve probably read all the stuff that you have. I’m skeptical.

I also think it’s hard to imagine the IRS, Treasury etc allowing anonymous transactions without any reporting becoming a global standard for US persons.

But I’m willing to look beyond that because the goddamn thing won’t go away. I was talking with Justin Paterno (StockTwits) the other day and his attitude toward it is pretty much where I am – “Anytime something just refuses to die, you probably have to pay attention to it.” Bitcoin, if it were complete and utter nonsense, probably should have died already. But 7 years since it burst into the public consciousness – with all of the attendant volatility and criminal activity you’d expect to come along with something so new and unproven – and it’s still here. Despite the hacking and stealing and malfunctions and crashes, it’s still a thing. It’s the f***ing rooster. Ain’t found a way to kill me yet…

Anyway, I’m not a disruption hippie or an early adopter or a visionary or an evangelist. But I’m too curious to not experience Bitcoin ownership for myself. Oh, by the way, I don’t see myself trading it on price swings, more on that in a second.

So I used Coinbase, which from what I gather is the “safe” way to buy, sell and store. We’ll see. I began with a small amount of money so if they hack the site tonight and empty everyone’s wallets, I won’t feel it. The process was fairly simple.

First you create an account and connect it to your phone and email. They text you a code to verify and send you an email to confirm. No big deal. Then you connect a bank account, which only takes a second. From there, Coinbase makes two small deposits into your bank (pennies, don’t get excited) over the next 48 hours. You log back in and report what those tiny deposits were so it can verify the connection to your bank. Once that’s done, you can transact.

I bought some BTC, although ethereum and litecoin were also on the menu. I look at those other two like silver and bronze to Bitcoin’s gold. But I’m just making that up. Ethereum (ETH) might one day be better because it allegedly has some technological advantages, but I’m a newb so I’m starting with the more established fake thing rather than the less established fake things.

Anyway, I expect a lot of volatility and I really don’t know what I will ultimately do with my digital thing. Maybe I will add to it or maybe I will buy ETH also at some point. It went up 8% today I think so already I’m a genius 😉

I think at this stage in the game, it’s important to be open-minded and not afraid to lose money or look foolish. I’ve invested into way dumber things in my life. And as far as what the future holds – if the disruption hippies turn out to be right, and the 21 million BTC that will eventually be the limit are out there in public hands, it’s hard to imagine them not appreciating in price. Especially if they become more institutionalized and embedded into enterprise scale transactions – which is what the banking industry seems to be leaning toward from what I read and hear. I like the idea of scarcity and owning something that is finite by design.

And yes, I am aware of the possible split in the community, I have no opinion about it and nothing worthwhile to add. I’ve factored this risk in mentally. The resolution of this scaling problem may turn out to be a powerful upside catalyst just as easily as it could lead to a panic. Brexit-esque.

One other thing. On the Silk Road two thousand years ago, you needed gold to settle transactions. Because from Korea to the Asian Steppe to the Mediterranean, there had to be one thing whose value was never questioned. Gold facilitated trade and liquidity from one end of the known world to the other. My opinion is that this property of the element – it’s universal acceptance – remained in force for centuries…until it was disrupted by the internet. Once computers arrived, we had instant access to values and prices of goods around the world. Gold’s role in global liquidity and verification suddenly mattered less. No one realized it at the time, but gold as a currency had been permanently disrupted by the microchip and the operating system.

The Information Technology Revolution began in the early 1980’s when the computer became first a ubiquitous business tool and then eventually a household appliance. It should come as no surprise when I tell you that this moment also was the inflation-adjusted high for gold, still unsurpassed almost 40 years later.

Blockchain technology may have just permanently disrupted traditional currencies. It’s obvious to me that even if this is true, we will not know it for sure until decades have gone by.

Bitcoin Bloodbath – But a Reminder: Wall Street Is Coming

Todays Bitcoin and Ethereum bloodbath was more or less expected ahead of the (potential) coming Bitcoin “Segwit” event. While this is causing major moves in the short term I think its prescient to remind the cryptocurrency community that Wall Street is on its way.  In the past we posted about what some of the roadblocks are, but with todays Bitcoin and cryptocurrency bloodbath we thought maybe some positive predictions were due.

Yesterday we posted some concrete evidence, but there are some other speculative indicators.

First, trading in “traditional” (stocks, options, bonds, etc) Wall Street products is flat, at best. There is nothing indicating that those traditional volumes will pick up either. (See JPM trading revenues, weak). [Note, other areas of banking appear to be strong – I am referencing the trading sector specifically]

Take a look at US stock and options volume for example. Yes, there is some deviation month to month but its been flat for years.

US Daily Stock Volume
US Daily Stock Volume
US Exchange Options Volume
US Exchange Options Volume

Its no secret that Hedge Funds are having a hard time. They are a major source of banks trading revenue. Why, well multiple studies show that buying and holding over time crushes Hedge Fund performance. Vanguard is the poster child of this, and is growing at a ridiculous pace offering investors low cost ETFs. Whats my point? This is good for investors but terrible for Hedge Funds and Banks.

Trading desks on Wall Street need a new revenue source. Enter Bitcoin, Ethereum and cryptocurrencies.

All of this is could be brand new business in a market that is expanding rapidly.

Crypto Volume is Exploding

High volumes mean dollar signs for brokers. All evidence points to volumes that rival US Stock Exchange volume.

Below is Bitcoin 7 day average volume. I’d suspect most would argue that this volume will continue to grow over time – if not in Bitcoin than certainly in other cryptocurrencies such as Ethereum or Dash.

Bitcoin Volume
Bitcoin Volume

Just a few days options trading in Bitcoin was approved by the CFTC (US Commodities Futures Trading Commission). This means that regulators are starting to turn positively on Bitcoin and crypto. This is great news for banks in particular as they can more easily move into cryptocurrencies when the regulators are approving.

This offers opportunities not just in trading – but in services for trading:

  • Cryptocurrency clearing and storage
  • Research and Analysis
  • “Smart Routing” and algorithmic trading

It would be easy to argue that as more large entities enter the space, more technology is built and more capital flows in. While today Bitcoin prices are getting hammered, we’re in the first inning of a game that most likely will not end in our lifetimes. Reminder: this isn’t investment advice, just an offering of perspective.

Why the Recent Bitcoin Price Explosion Was a Dry Run

The recent rise and fall of Bitcoin and Ethereum prices brought massive attention to the cryptocurrency space. While that fevered speculation created a short term price spike that proved to be unsustainable, the price move also put a spotlight on the viability of cryptocurrency from investment and technological perspectives.

The Recent Bitcoin Ethereum Price Spike was Fast Money

Fast money – money that floods in, speculating on price. Thats what pushed up prices not of just Bitcoin and Ethereum, but every other cryptocurrency over the last few months. Fast money leaves just as fast as it arrives. Fast money brings “weak hands”. These are speculators that don’t have conviction or a belief in what they are investing in. They freak out when price moves against them by more than a few percent.

Ethereum Price Chart June 2017
Ethereum Price Chart June 2017

Fast money tends to be smaller amounts. Why? Because if you are a large piece of the market you can’t liquidate that easily. For example, if you own 75% of all Bitcoin you’re going to have a much harder time selling that if you own 7 bitcoins.

While this recent price spike and subsequent drop probably burned a lot of people, it may have set the stage for much larger investment. Ethereum and Bitcoin were plastered all over the news, on CNBC, Wall Street Journal and the like. Coinbase, for example, had record account openings. These are people who figured out where to go to buy crypto (I’d argue thats not an easy task) and that paves the way for future investment. There are millions more people who now have not only heard of Bitcoin and Ethereum, but they will remember that they missed the boat last time. I’d wager they’re more ready to participate in future price ramps.

Big Money Is Coming to CryptoCurrency

Wall Street and major investment is moving to the cryptocurrency space. You see it happening all over, and that is money that is making real investment in cryptocurrency and that could help set a floor in Bitcoin and Ethereum price. This is money that takes longer to impact the price. Business plans, approvals, infrastructure all has to be built before actual money moves in.

Here are just a few examples:

I think this bodes very well for the future of cryptocurrency. Fast money “set the stage” for larger participation in the future. If Wall Street and other large corporations continue their push into the space that should “legitimize” crypto in the eyes of the public and could pave the way for more capital flowing in.

Ethereum Has a Mining Problem

Ethereum Price Mania Leads to Mining Hardware Mania

The mining difficulty for Ethereum has been rising steadily, but it really spiked over the last several days. Coupled with a sharp drop in Ethereum price, this creates an issue which makes mining less profitable, or even a loser. If miners bail on Ethereum that makes the network slower, which is obviously a bad thing.

Ethereum Mining Difficulty Chart
Ethereum Mining Difficulty Chart

There are two possible reasons for this:

  1. More miners jumped into the game, increasing the difficulty
  2. Its something that the Ethereum developers are purposefully doing

Ethereum Mining Hardware Sold Out

A recent article from TweakTown states “The cards [mining equipment] are either selling out, are sold out, or they’re being sold for ridiculous prices in the second hand market. (As a strange side note: Millennials #1 stock purchase on Robinhood is AMD) PC World says ” mainstream graphics cards like the superb Radeon RX 570 and RX 580 can’t be found right now, with all models either out of stock or selling for wildly inflated prices online.”

So what?

Well, more miners means more competition for mining. To me the above means that “speculators” are diving in, rather than guys with a concrete, long term business plan. As competition heats up it means less return on investment for miners, be it huge server farms or the Average Joe with one RX580 in his parents closet. When the Ethereum price drops as it has been recently, this can make mining “cost ineffective” wherein the cost of electricity is more that the value of Ethereum you can mine. If your return on investment is calculated using a price thats up 5000% over the last several weeks, you’re probably in trouble.

I posted the chart below in reference to the Ethereum price, but it could work as an analog for mining hardware, too. The time for buying mining hardware was the “Stealth” or “Awareness” phase. Overspending on mining hardware based on “Mania” Ethereum prices is a recipe for failure.

Investment Cycle
Investment Cycle

Coinwarz has in depth information on mining ROI for those interested.

The Ethereum Difficulty Bomb

Its not 100% if its simple “mining mania” due to speculators, or if the mining difficulty increased. Ethereum uses an algorithm dubbed “DAG” which can essentially vary in complexity. The more complex the solution is to the algorithmic problem, the harder it is to solve aka “mine”. A tougher problem takes more computing power to solve the problem.

More on the bomb from The Merkle:

From the outset, the plan was to make Ethereum mining impossible at some point in the future.This change will be introduced through an arbitrarily difficult block to mine, which will effectively create the difficulty bomb in question. As this difficulty bomb is activated on the network, the mining difficulty will skyrocket and eventually make Ethereum mining unfeasible and extremely unprofitable.

This “bomb” was apparently an intended feature built by the Ethereum developers and leads to a lengthy discussion around “Proof of Stake”[POS]. (read about that here) For purposes of this post, I’ll just note that POS is supposed to be the answer to this mining issue. The problem is that POS does not have a hard launch date, but should be out “by the end of 2017” according to Vitalik Buterin the head of Ethereum.

Ethereums Future Needs Proof Of Stake

Higher and higher difficult combined with lower prices just won’t work. If prices drop, then some miners should back out and hopefully things find an equilibrium again. Proof of Stake is something that many in the Ethereum community has been focused on for a long time, and its delivery is not just important for the Ethereum technical network to actually operate, but also the confidence people have in the Ethereum product.

I could actually make the case that whats best for Ethereum is people forgetting about it for a while. Mania leads to network issues and things breaking that just haven’t been tested yet. This is the first or second inning of a very long game, and no one can predict the future off of what has transpired in the last few weeks. There are many potentially amazing things in the works, roadmap here.

This BTC/ETH Price Analog Is Working

What follows below is rampant speculation. Do not take any of this as investment or trading advice.

Bitcoin vs Ethereum Price Charts

We originally posted this analogy comparing the first (2013) exponential ramp in Bitcoin to the Ethereum price ramp of the last few months. This isn’t a prediction, but I find it quite interesting. You could make a case that Ethereums price is tracking this initial run of Bitcoin.

Ethereum now vs Bitcoin 2013
Ethereum price ramp compared to bitcoin ramp.

This chart of stock market bubbles (or any investment mania, I suppose) is well known, and seems applicable here. If I had to toss a guess, we’re in the bull trap phase. Ethereum is right around ~$200 now and I’d speculate that round numbers often prove to be support areas.

Investment Mania

Another interesting thing about this analogy – the Bitcoin hard for is 20 days from now. There was 20 days between the “Bull Trap” phase and “Return to Normal” in the Bitcoin price bounce. If Bitcoin forks on August 1st that could have a major price impact on all cryptocurrencies and drive real “Fear” into the crypto market.

Bitcoin Peak to Trough vs Ethereum

We’ll keep updating this chart to keep an eye on this analogy. While I believe in Ethereum long term, the Bitcoin fork and Ethereum ICO’s it could make for a bumpy road in the short term.

Ethereum Has an ICO Problem

Initial Coin Offerings (ICO’s) are raising hundreds of millions of dollars on pretty much hopes and dreams, using an Ethereum platform which is in its infancy. (Some ICO sales even jammed up the Ethereum network). I say hopes and dreams because despite raising mounds of cash they aren’t near releasing product. Seriously, here are just a few:

  • Tezos currently raised >$200 million, and the funding isn’t over yet
  • Bancor raised $153 million
  • Block.one / EOS raised $185 million

The total amount raised in ICO’s in 2017?

>$798,251,174

That is staggering.

How Initial Coin Offerings Hurt the Ethereum Price

Raising “cash” isn’t really the right word. They’ve raised heaps of Ether, which they need to sell in order to get cash. What does this mean? You have hundreds of millions of dollars in Ether either being sold, or potentially being sold.  Its quite possible these companies only sell portions of their holdings, or even none at all. However, these companies need to use the funds to hire developers, buy computers, or just take exotic vacations. (Remember, there are no regulations in ICO land.) Its therefore a reasonable assumption that there is a good amount of Ethereum supply created from this.

The ICO’s need to start adding actual value to the ethereum network. They need to provide a service thats good enough to bring new people into Ethereum. This would raise demand for Ethereum and should raise the price. As of now this is all just a transfer of wealth from existing ETH holders to various “start ups”, with the hope that value is created at some point in the future.

Here is a beautiful graph that lays out how much has been generated by ICO’s in 2017:

ICO Sales by Month

For sake of argument, lets just say that all of the funds will be used for legitimate business purposes. Again, they need to sell Ether to get cash to buy stuff or hire people. This means you have many sellers that have a desire to get out, for which Ethereum needs aggressive buyers. If the sellers are more aggressive than the buyers, you get a price drop.

If you use google trends as a proxy for Ethereum demand, well, you can see why the price is currently ~$250 down from $400 a few weeks ago.

ETH is trending down on google.

Notice a trend? Both peaked in June 2017. What about the Ethereum price? Peaked in late May…just before the huge ICO month in June. I can’t say for certain that the two are related, but I’d speculate there is some correlation for good reason.

Ethereum Price July 2017

Short Term Ethereum Price Forecast

First, Ill state I have no clue where ethereum prices are going. I also own ethereum. Also, the short term picture is different from long term. Long term I have high hopes, but this is about the next few months.
To recap:

Where does this leave us? Hard to paint a pretty picture there. With more ICO’s coming daily there will be more ETH supply from companies needing cash. Eventually one of these will turn out to be a “killer app” or at least an app that maims. This would draw actual users to Ethereum, as opposed to speculators. Who knows when this will happen, but I suspect within the next year well see the technology start to move up towards the hype. This would in theory bring in new capital and get the Ethereum price moving in the right direction again.

 

DO NOT BUY BITCOIN ETN’s

While the SEC messes around trying to rule on the Winklevoss Bitcoin ETF (ticker:COIN) they are ignoring the riduclous premiums in the Bitcoin ETNs. The Bitcoin Investment Trust (ticker: GBTC) from Greyscale trades in the USA and XBT which trades in Europe. XBT just broke $100 million in assets and works with XAPO for cold storage.

This is just my opinion, but:

DO NOT BUY BITCOIN ETN’s

Lets focus on GBTC for sake of argument.

Current Bitcoin prices are ~$2,514

GBTC trades at ~$388/share

GBTC has 1,868,700 shares outstanding, which they say gives each investor 0.09273259 Bitcoin per share.

1,868,700 GBTC shares outstanding * 0.09273259BTC/share = ~173,289 Bitcoins in holding

$388/share GTBC * 1,868,700 GBTC shares = market cap value: $725,055,600

$725,055,600 mkt cap/173,289 Bitcoins = ~$4,184/bitcoin

Therefore, if you buy 1 share of GBTC at 388, you are paying ~$41 for ~$23 worth of Bitcoin. Thats an absolutely absurd >150% premium. Not to mention the 2% annual fee GBTC charges.

This premium is not the GBTC’s fault. Its investors that need their heads checked. GBTC cannot reweight their Bitcoin holdings in anywhere near real time. The Winklevoss ETF, should it make it through the SEC, would reweight much more often giving investors a vehicle which more closely tracks the actual price of Bitcoin.

How to Hedge SegWit – The Bitcoin Fork

August 1st is when the fun begins in Bitcoin. “BIP148” (aka “User Activated Soft Fork” dubbed UASF) is activated and the world finds out whether Bitcoin stays together or splits in two. If this is unfamiliar to you, then read here, or here or just give “SegWit” a googling. Avoid trying to research this on twitter, because you will find little outside of ad-hominem attacks between groups who cant agree on the best way to scale bitcoin. While I only have a peripheral understanding of the arguments what I do understand is that there is a real possibility of any of the following:

  1. The majority gets together and Bitcoin moves forward intact
  2. Bitcoin splits in two
  3. Bitcoin splits in two…hundred.

Why is there so much Bitcoin infighting?

I think it boils down to how much money is involved now. Bitcoin mining generates roughly $4million/day (1,700 bitcoins mined per day * $2,500/bitcoin). Thats big money. Money is a leading cause of divorce, and it appears thats whats ahead for Bitcoin.

How Does a Fork Impact Bitcoins Price?

At a minimum we will see Bitcoin transactions slow a great deal starting on August 1st. The Bitcoin community has argued about this for months, and it seems that even if Bitcoin does not fork there is a significant number of people who won’t go quietly into the night. If you hold Bitcoin today and there is a fork, you’ll likely end up with two new “types” of Bitcoin in your wallet (this happens automatically).

Ethereum went through a fork not too long ago, and it was pretty seamless. If you had Ethereum in your wallet, the next day you woke up to both the “new” ethereum and the “old” ethereum in your wallet.

Certainly Bitcoin splitting would hurt the price, at least initially.  Regardless of outcome party lines are so split that it’s hard to envision smooth sailing over the next few months. Who knows which version of Bitcoin to bet on? The general public is just warming up to Bitcoin and crypto – and know there will be several versions? Picture logging into your Coinbase account, ready to buy bitcoin for the first time. Surprise! There are now two versions. Which do you chose?

To me, this paints an ugly short term picture. I think this could hurt or at least keep a lid on Bitcoin prices for the short term.

How to you Hedge the Bitcoin Fork?

  1. Keep holding you Bitcoin and come back in 6 months. Its quite possible the fork produces two (or more!) versions of Bitcoin which both attract investment and you will have equally or more crypto value in a few months. Or, one of the two versions rockets ahead in price. No one knows whats on the other side of this forking.
  2. Move to cash. Bitcoins had a nice run…let the dust settle then figure out where to allocate your funds. (Side note, I’ve heard Tether can help here but have not investigated).
  3. Other Crypto: More below:

There are some very viable alternatives to Bitcoin, that are more or less copies of Bitcoins code. Many don’t realize that you can simply copy bitcoins current code, paste it into a distinct infrastructure and, voila, you have your own cryptocurrency. While this is indeed a massive oversimplification, the point is while two groups are hell bent on controlling the future of bitcoin, others are taking what they love about Bitcoin, making a few tweaks, and providing a cohesive alternative. Cohesive meaning the people with skin in the game aren’t at each others throats.

I chose the two below because they already have a fairly substantial market cap and existing mining hardware for bitcoin could flip to mine these other currencies. Bitcoin mining hardware isn’t “fungible” to all cryptocurrencies. Bitcoin mining hardware cant mine Ethereum for example.

This detail about mining is important. If you run a large mining operation you can’t simple close up shop because you think Bitcoins future is destroyed. There are bills to pay. You can however move to an alternative currency and I suspect most of these guys have fork contingency plans in place. Note that you could write dissertations on each currency. So, do some homework before investing.

My best bets to pickup Bitcoin market share?

  • Dash – Has a voting system in place (which resolves issues like forking quickly) and a unique structure to help fund future development.
  • Litecoin – Widely available its probably more accessible to new investors (at the time of this writing). Coinbase for example has Litecoin, but not dash. Litecoin’s sales pitch is essentially that its network is lighter and faster that Bitcoin.

It’s very hard to say what the best play is – what makes this so murky is the political split between Bitcoin factions. To me this is what makes investing in other currencies such an attractive idea.

After the Bitcoin Fork

Six months from now the dust should be settling and the crypto landscape will definitely look different. Its hard to remember that just a few years ago none of this existed and now its a multi billion dollar industry. Remember, regardless of what happens with the Bitcoin fork there are incredible developments ahead. 10 years from know this will all be just a blip on the radar – maybe that means there is no wrong way to play it.

 

Gemini Exchange Auction

The Gemini Bitcoin Ethereum Exchange has an interesting Auction mechanism which deserves a look for active traders.

About Gemini Exchange

Gemini is a US exchange started by the Winklevoss twins of Facebook fame. Its a regulated US exchange which offers a bit more security as a result. The Winklevoss are also working on a Bitcoin ETF which is pending SEC approval.

The Gemini Exchange Auction

Here is how Gemini describes their Auction:

In addition to the continuous trading order book, each of the order matching engines conducts two Auctions (or “crosses”) every day, one at 4:00 p.m. Eastern Time (20:00 UTC during EDT and 21:00 UTC during EST) and one at 7:00 p.m. Singapore Time and Hong Kong Time (20:00 JST, 11:00 UTC). This provides an opportunity for both buyers and sellers to trade in an instant of elevated liquidity and price discovery. All active orders (including resting limit and MOC orders) may interact with the Auction and influence the final auction price, which is determined by finding the price at which the greatest aggregate buy demand and sell demand are fulfilled. All participating, eligible orders are fulfilled at the final auction price. (We use a mechanism similar to the New York Stock Exchange’s Arca marketplace, Nasdaq, Bats, and other large stock exchanges throughout Europe and Asia, which is sometimes called Walrasian equilibrium.)

In the stock trading world Auctions are useful because it allows you to trade “size” (aka large orders) without (hopefully) having much impact on the stock price. If you are a large hedge fund and need to offload 5 million shares you can really push the price of a stock down, especially if you are a large part of the volume. Theoretically the auction might allow you to cross (aka match in the auction) with a large buyer without having a major impact on the price of the stock.

There are a bunch of stats on the Gemini Auction here.

On the stats page, there are a few interesting things. There are about 340 data points and the average “Absolute Difference” between the midpoint on the “continuous market” (aka normal price) vs where the Auction Matched price is 0.27%. With Bitcoin at ~$2,500 thats about $7.  The highest spread though was 3.83%, with a standard deviation of 0.41%. Remember, these are ABSOLUTE numbers, so you don’t know if the auction price is higher or lower.

A real statistician would rip my math apart here, but basically this says that you have a 66% chance of achieving a  price thats almost 1/2 a percent from where the continuous market is trading.

For the average joe, this isn’t worth much. The price of Bitcoin or Ethereum can move 1/2% in a few seconds so you’re opportunity to lock in an arbitrage seems a random. But, if you are a market maker or an arbitrager using an API to trade instantly its pretty interesting. Not only could I use the difference in price between the “continuous” exchange on Gemini and the Auction mechanism, but I could also arbitrage between any one of the other exchanges like GDAX, kraken, OKCoin, etc.

 

Bitcoin & Exchange Arbitrage

First, some caveats. I spot checked exchange websites to verify these prices. It appeared like I could trade the Bitcoin/USD pair on each of these exchanges. How the exchanges adjust their local currency into USD could cause the price differences. For example, the Chinese exchange might use a delayed quote to adjust their price from Yuan to USD for advertising purposes. Then, when you try to trade you’ll see a different quote. What follows below is just a thought  exercise – do not take it as anything more.

Want to make ~10% of your money instantly?

Buy bitcoin on Poloniex and sell on LakeBTC. Poloniex lists themselves as a Wilmington, DE company whereas LakeBTC is Chinese. So if that geographical difference bothers you, then flip to GDAX or Gemini vs Poloniex where the arbitrage is closer to 5%.

The USD Bitcoin Price Spread by Exchange

Why is the Price Difference Between Bitcoin Exchanges so Big?

There is no real linkage between various Bitcoin Exchanges. Historically stock exchanges didn’t have linkages either and it was market participants who made their living arbitraging between exchanges. As more arbitrage players step in the price spread between exchanges shrinks. More players, more competition, smaller (aka “tighter”) spreads.

Why haven’t arbitrage players/market makers jumped into Bitcoin?

Well, many have. There are players in the arb game already but there are some challenging barriers to entry.

Exchanges often have API’s which allow you to connect and with a bit of code you could be on your way. Now the fun part.

Bitcoin wallets are local to the exchange.

There is no “central” wallet (that I’m currently aware of) which all the exchanges connect to. If you are trading on OKCoin you have to have a bunch of funds on that exchange. If you want to arbitrage against Gemini you need funds there, too. What happens if you buy a bunch Bitcoin on OKC and then need to sell a bunch on Gemini? Suddenly you’d be out of cash on OKC and flush with cash on Gemini. You then need to either transfer cash or Bitcoin to OKC so you can buy more on that exchange.

Great, lets transfer more cash to OKC:

This can be time consuming – will the exchange take in the funds instantly? When arb’ing time is of the essence. Additionally, many exchanges won’t take US customers. Some find ways around this of opening local companies and local bank accounts. Enter in the issue of currency.

If you’re  primarily in USD’s you might have to account for the currency conversion to the local exchnages currency. OKC is in China, so you have to get USD into Yuan and factor that into your arbitrage. When the price spread is $200 between exchanges this might not matter much – but when that spread gets tighter it may become a problem.

Option two: send Bitcoins from Gemini to OKC: Generally this is cheap and efficient. BUT, Bitcoin has been known to have some network issues that slow down the transfer of Bitcoin from one wallet to another. Particularly when the prices are really moving fast. As an arbitrager its when markets are moving fast that you’re most likely to have to move Bitcoin between wallets. Lets say you need funds at OKC immediately because you sold some at Gemini – a 5 minute delay in sending coins could wipe out your arbitrage.

Keep in mind – most arbitrage players want to trade on many exchanges simultaneously not just two. You can see how this could get confusing quite quickly.

These problems are solvable, but far from trivial.

Enter Bitcoin Exchange “counterparty” risk.

Alright, you need to keep a bunch of funds distributed to all the various exchanges on which you trade. As any long time Bitcoiner will tell you, keeping funds on an exchange brings a lot of risk. You’re exposed to everything from hackers hitting the exchange (see Poloniex) to the people that own the exchange just deciding your funds are theirs (see Mt. Gox). Certainly exchanges are getting better and more secure as they evolve. Buy lets say the Konim exchange messed up your wire transfer. They’re Turkish – do you speak Turkish? There are also plenty of stories involving US Banks which aren’t wild about your evil cryptocurrency related money transfers. So they hold up your funds.

These and others are all risk that you have to consider.

All that aside, it appears there is money to be made. Its also a safe bet that more players are going to pile in, technology will improve and the price difference between exchanges will close up. For most of us normal “buy and hodlrs” that means more efficient markets.