Bitcoin's tick problem (get fooled on cryptographic exchanges)

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Dan Cawrey is the CEO of Pactum Capital, a financial services company focused on risk management with cryptocurrency derivatives.

The following is an exclusive contribution for the 2018 year of CoinDesk under consideration.

2018 years in review
The published writers say it. Powerful business men say so. The elite athletes say so. Investors with a track record of smart decisions say it; "Consistency is the key to success".

In cryptocurrency, many investors say that bitcoin is a store of value, a digital version of gold. But bitcoin does not behave like gold, offering a stable way to maintain long-term value. Bitcoin often seems a rather inconsistent and manipulated market. For example, why does bitcoin trade at one-hundredth of a tick compared to most major cryptocurrency exchanges?

& # 39; Tick size & # 39; This term refers to the minimum quotation and the amount of trading available on a stock exchange. When the bitcoin was worth a few dollars, a dime made sense. When the bitcoin was worth $ 100, penny ticks were reasonable.

With over $ 1,000, it creates problems. Permanent orders disincentive while incentivizing volatility.

Imagine this scenario: Bitcoin exchanges for $ 3,500.03. A human trader puts in a limited order to buy for $ 3,500.00. An automated trading system then "penny skips" the human trader by entering a small purchase order at $ 3,500.01.

The systematic merchant's order will be filled first.

Automated cryptocurrency trading systems are comforted in these scenarios. This is because the orders of human traders must be filled before they lose money. Therefore, systematic exchanges will always be a step ahead of any human being with such tight spreads. This happens constantly on the exchanges of cryptocurrency.

High-volume bitcoin traders use systemization algorithms. The average trader uses manual or simple bot orders. These are not easily adjustable on the fly for the whims of the low sizes.

The one-cent orders suddenly appear and disappear in the bitcoin exchange books. This is because there is very little disincentive to place orders at a 1 cent tick. Source: Coinbase Pro

Bitcoin behaves differently than any other financial asset that many have ever traded.

Most people who buy financial assets try to get the highest amount at the lowest possible price. Bitcoin is often the opposite, however. Traders try to buy the minimum possible at a higher price.

This is particularly true with a checkmark due to a combination of reduced order sizes and tiny spreads.

This has been studied before

In the foreign exchange and stock markets, there are some precedents that change the size of the ticks.

Forex markets, for example, have decided to do an experiment: reduce the total size of the tick for currencies from what is called pip (0.0001) to the decimal pip (0.00001).

The result? Other high-frequency traders with computer algorithms "jump" traders regularly. This has created irregular prices, as basic bots and human operators simply do not take into account more decimals.

Source: Journal of Banking and Finance, vol. 85, 2017

The SEC has also reviewed this. They ran a tick-sized pilot with small-cap stocks. The results show more depth, but a decrease in price quality. Furthermore, the increase in depth seems to be related to large market orders. Crypto does not involve millions of dollars in transactions very often – which runs in the store, not in the spot market.

Imagine, for example, that the dimensions of the ticks for crypto were even less than one cent. This would mean more opportunities for advanced HFT and less for retailers. Conversely, having higher sizes would mean better commercial benefits for average investors.

The bigger the tick, the better the trading, which is getting the maximum amount for the lowest price, as mentioned above. The smaller the tick, the worse the average price trades / investors get.

A call to encryption exchanges

Exchanges should take into account the fact that changing the size of the ticks is clearly not a crazy idea. In reality, it is something that should be experienced given the nature of the crypt as a new era in finance. In fact, having a larger tick size in the crypt is not without precedent. CME, for example, lists bitcoin futures with a value of $ 5 tick.

The addition of inefficiencies to the market seems like an existing banking system, is not it? Some may argue that the increased spreads are bad because they create profits for intermediaries who actually do nothing.

In fact, spreads in the markets have a purpose. There is no specific rule on this in itself. (Only the wisdom that the optimal spread should be as narrow as possible). This means that offers and requests should be close to each other, while continuing to attract sufficient liquidity on both sides to make transactions.

Still, it is clear that at this time, a penny spreads into bitcoins not attracting enough liquidity to be traded to the best offer and supply. There are only a few jumps in progress, with the orders placed and removed all the time. This is the reason why the small size of the ticks are really difficult to understand from the trading point of view.

Increasing the bitcoin tick size from a penny to $ 0.50 or $ 1 would do much to level the playing field for human traders. It would also increase the cost for operators who currently rise and manipulate the overall price.

Pactum Capital focuses on the trading of cryptocurrencies and market making. Our company is sometimes several percentage points in the daily volume of trade settled in the United States. But the size of the bitcoin ticks leaves us perplexed.

So, why do bitcoins keep trading with a penny tick in most major exchanges?

This is a question we would like to see answered in 2019.

Have an opinion of 2018? CoinDesk is looking for proposals for our 2018 under consideration. News via e-mail [at] coindesk.com to learn how to be involved.

Open the clock via Shutterstock

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