The following is an exclusive contribution to CoinDesk’s 2018 Year in Review.
2018 year in review
Published writers say it. Powerful businesspeople say it. Elite athletes say it. Investors with a diary of smart decision-making say it; “Consistency is that the key to success.”
In cryptocurrency, many investors say bitcoin may be a store useful , a digital version of gold. But bitcoin doesn’t behave like gold – offering a stable thanks to hold value long-term. Bitcoin often looks like a reasonably inconsistent and manipulated market. as an example , why does bitcoin trade at a penny tick size on most major cryptocurrency exchanges?
‘Tick size’ may be a term meant to ask the minimum quoting and trading amount available on an exchange. When bitcoin was worth a couple of dollars, a penny tick size made sense. When bitcoin was worth $100, penny ticks were reasonable.
At over $1,000, it creates problems. It disincentivizes standing orders while incentivizing volatility.
Imagine this scenario: Bitcoin is trading at $3,500.03. a person’s trader puts during a limit order to shop for at $3,500.00. an automatic trading system then “penny jumps” the human trader by fixing alittle buy order at $3,500.01.
The systemized trader’s order will get filled first.
Automated cryptocurrency trading systems take comfort in these scenarios. this is often because the orders of human traders got to get filled before they lose money. Therefore, systemized trades will always be one step before any human with such small spreads. This happens constantly on cryptocurrency exchanges.
High-volume bitcoin traders are using systemization algorithms. the typical trader is using manual or simple bot orders. These aren’t as easily adjustable on the fly to the whims of low tick sizes.
One penny orders suddenly appear and disappear on bitcoin exchange order books. this is often because there’s little or no disincentive to put orders at a 1 cent tick. Source: Coinbase Pro
Bitcoin behaves unlike the other financial asset many have ever traded.
Most people buying financial assets attempt to get the very best quantity for rock bottom price possible. Bitcoin is usually the other , however. Traders attempt to buy the smallest amount amount possible at a better price.
This is very true with one penny ticks due to a mixture of small order sizes and tiny spreads.
This Has Been Studied Before
In the exchange market and equities markets, there’s some precedent to changing tick sizes.
Forex markets, for instance , decided to try to to an experiment: Lower overall tick size for currencies from what’s called a pip (0.0001) to decimal pip (0.00001).
The result? More high frequency traders with computerized algorithms “jumping” regular traders. This created uneven pricing, as basic bots and human traders simply don’t account for more decimals.
Source: Journal of Banking and Finance, Vol. 85, 2017
The SEC also did a review of this. They performed a tick size pilot involving small cap stocks. Results show increased depth, but decreased price quality. additionally , the depth increase appears to be associated with large market orders. Crypto doesn’t entail many dollars in trades fairly often – that’s executed in over-the-counter, not the commodity exchange .
Imagine, for instance, that tick sizes for crypto were even less than a penny. this is able to mean more opportunity for advanced HFT and fewer for retail traders. Conversely, having higher tick sizes would mean better trading advantages to average investors.
The larger the tick, the higher for trading – which is obtaining highest quantity for rock bottom price, as mentioned about. The smaller the tick, the more severe pricing average traders/investors get.
A Call to Crypto Exchanges
Exchanges should listen as changing tick sizes clearly isn’t a crazy idea. In fact, it’s something that ought to be experimented with given the character of crypto as a replacement era in finance. Indeed, having a bigger tick size in crypto isn’t unprecedented. CME, for instance , lists bitcoin futures with a $5 tick size.
Adding inefficiencies to the market, seems like existing banking, doesn’t it? Some may argue increased spreads are bad because it creates profit for middlemen who don’t actually do anything.
Actually, spreads in markets do serve a purpose. there’s no specific rule on this intrinsically . (Only the wisdom that optimal spreads should be as tight as possible). this suggests bids and asks should be approximate while still attracting enough liquidity on either side of it to transact.
Still, it’s clear that immediately , one penny spreads in bitcoin don’t attract enough liquidity to transact at the simplest bid and offer. There’s just a bunch of jumping happening , with orders placed and removed all the time. this is often why small tick sizes are really hard to know from a trading point of view.
Increasing bitcoin’s tick size from one penny to $0.50 or $1 would go an extended way in leveling the playing field for human traders. it might also increase the value for traders currently penny jumping and manipulating the general price.
Pactum Capital focuses on cryptocurrency trading and market making. Our firm is usually several percentage points of daily volume on regulated U.S. exchanges. But, bitcoin’s tick sizes are continually perplexing to us.
So, why does bitcoin still trade with a penny tick size on most major exchanges?
It’s an issue we’d wish to see answered in 2019.
Have an opinionated combat 2018? CoinDesk is seeking submissions for our 2018 in Review. Email news [at] coindesk.com to find out the way to become involved .