Exchange Design: Evidence from Cryptocurrency Exchanges
The roots of Bitcoin and cryptocurrency are in decentralization. The underlying blockchain technology is designed to replace a central clearinghouse for record keeping. Interestingly, perhaps ironically, to date the largest economic activity for cryptocurrency, particularly, Bitcoin is seen on centralized ex- changes. Both the trading volumes and the sheer number of different exchanges are surprisingly large. CoinMarketCap tracks the market capitalization (price times outstanding currency) of 200 different cryp- tocurrencies with a total market cap of $204 billion. They track even more exchanges. CoinMarketCap tracks 306 cryptocurrency exchanges – 25 of those had daily volume over $500 million.
Perhaps the prevalence of central exchanges is not surprising. The wide dispersion in perspectives on the value of cryptocurrencies leads both to a motive for trade and substantial price volatility. The underlying blockchain is, at least as implemented currently, poorly suited to high-frequency trading. It does not offer speed of execution, volume, or certainty of trade necessary for financial trading. This gives a role for central exchanges that can deliver high speed and volume trade using exchange contracts backed by a cryptocurrency. On-exchange trades happen quickly since traders are swapping liabilities of the centralized exchange. Interactions of the exchange with the underlying blockchain currency are far less frequent; typically when traders move assets into or out of the exchange.
The exchanges have broad similarities from contract characteristics to the look and feel of the order book display. But also a large variation in the design of the exchange. For example, exchanges differ in the contract features, the amount of leverage, settlement characteristics. They also differ in ways that are unseen in traditional financial markets like active chat groups, leaderboards, position disclosures. One major source for the heterogeneity is their approach to regulation. Some exchanges embrace compliance (e.g., Bakkt) while others limit operations to avoid regional regulations (e.g., Bitmex does not allow US customers).
This diversity of exchanges makes for a good setting to study financial market design. In this project, we use data from three exchanges to understand the implications of makret design.
Perhaps the prevalence of central exchanges is not surprising. The wide dispersion in perspectives on the value of cryptocurrencies leads both to a motive for trade and substantial price volatility. The underlying blockchain is, at least as implemented currently, poorly suited to high-frequency trading. It does not offer speed of execution, volume, or certainty of trade necessary for financial trading. This gives a role for central exchanges that can deliver high speed and volume trade using exchange contracts backed by a cryptocurrency. On-exchange trades happen quickly since traders are swapping liabilities of the centralized exchange. Interactions of the exchange with the underlying blockchain currency are far less frequent; typically when traders move assets into or out of the exchange.
The exchanges have broad similarities from contract characteristics to the look and feel of the order book display. But also a large variation in the design of the exchange. For example, exchanges differ in the contract features, the amount of leverage, settlement characteristics. They also differ in ways that are unseen in traditional financial markets like active chat groups, leaderboards, position disclosures. One major source for the heterogeneity is their approach to regulation. Some exchanges embrace compliance (e.g., Bakkt) while others limit operations to avoid regional regulations (e.g., Bitmex does not allow US customers).
This diversity of exchanges makes for a good setting to study financial market design. In this project, we use data from three exchanges to understand the implications of makret design.
Nicholas Christin
Project Lead
Bryan Routledge
Project Lead
Ariel Zetlin-Jones
Project Lead