In the classic 80s Sci Fi Epic, “The Highlander”, immortal beings battle through time to be the last one on the planet. That movie provides interesting metaphors for the crypto markets. First, it describes how many of the leading crypto exchanges have opted to “go it alone” rather than work with their competitors. Second, it describes views on coins themselves, as represented by Bitcoin Maximalists and their derision towards “Alt Coins”. In my opinion, the lack of exchange cooperation is problematic for the growth of the market, but before describing why, lets first discuss the Bitcoin vis a vis Alts.
My view is that Bitcoin will eventually be viewed as “digital gold” by a critical mass of people globally. I tend to agree with Bitcoin maximalists to some degree, as I don’t see the value proposition for alternative digital assets that are solely marketed as a store-of-value. That said, there are many other use cases for digital assets including blockchain based platforms to automate contracts, loyalty (use) tokens, and efficient representations of “real” assets. Such assets will eventually create substantial value in my opinion, but they did not do so in 2019. Last year Bitcoin dramatically outperformed those “alts” and that trend may well continue.
In 2019, Bitcoin emerged from the “crypto winter” which took hold after its parabolic rise at the end of 2017, falling from around $19,000 to a bottom of just over $3000 in December of 2018. During the first six months of 2019, however, Bitcoin rallied 400% from those lows and, despite giving back 50% of those gains by November, it has (more or less) stayed in a trading range that is roughly 100% higher than its December 2018 low for the past 7 weeks. Other coins, however, did not fare so well. Ethereum, XRP and many others are trading lower today than they did as 2019 started and Litecoin (often called digital silver for some reason) is only higher by 30% or so, compared to Bitcoin’s 100% gain.
None of this price action is surprising, however, when one puts it into the appropriate context. Most of the “alt coins” are in a very early stage, relative to their potential use cases, and some have no clear use case at all. Bitcoin, however, has continued to gain traction towards becoming a legitimate alternative store-of-value to Fiat currencies. Longtime readers know that I have often said that Bitcoin trades as a long term option, on the possibility that it will gain a critical mass of people that believe in its value. IF it achieves that critical mass, it will likely be at a much higher price than it is today. For perspective, Bitcoin’s market cap is below $150 billion, while Gold’s current market cap is roughly $9 trillion and estimates of total monetary aggregates of Fiat currencies exceed $90 trillion. Thus, while the potential for Bitcoin to fail still exists, the continued growth in both transactions and infrastructure to support its widespread use is certainly a positive sign. Considering that Bitcoin would need to rally to over $400,000 per coin to approach the market cap of gold, I don’t think that it is too bold a prediction to say that it will continue to be volatile for the foreseeable future.
To get back to the Highlander metaphor, exchanges have (so far) not been willing to work with other exchanges to make it easier for investors to trade on multiple markets. To understand the issue, consider how the equity market operates. In the U.S., for example, there are more than a dozen operating stock exchanges that contribute to price discovery. Investors, however, can buy on one exchange and sell on another multiple times per day, without concern over settlement. In crypto, however, if one buys on one exchange, the investor must either sell it on that exchange or withdraw the crypto and transfer it to another exchange to sell it. That process is time consuming & difficult for many participants, which is why charts like this exist:
In this example, which shows a little over an hour of trading during the Jan 3rd early morning rally in Bitcoin, there was a few minutes where the bid on one major exchange was $100 higher than the offer on another. While this does not happen every day, it happens frequently enough to impact investor confidence. Clients of CoinRoutes, particularly if they manage their inventory on exchanges, can mitigate these effects, but such management requires some sophistication and risk management. As a result, while we anticipate that price dislocations between markets will become less and less significant, some discrepancies are inevitable until things change.
Perhaps more significant, however, is that inventory management issues have impacted exchange market share. Clients have opted to trade with OTC desks instead, who extend them settlement credit, in order to avoid the issue. If exchanges offered settlement credit or some form of cross collateralization with other exchanges, however, they could attract order flow from a wide array of clients. It should be noted, however, that settlement credit is different than leverage. Leverage means the ability for a client to buy or sell multiples of their crypto or fiat holdings, but settlement credit requires the ability for a client to settle all of their transactions within a defined period of time. As a result, the risk of providing settlement credit is more limited, and that risk can be outsourced to central networks or counter-parties willing to guarantee transactions.
While working together to facilitate cross exchange settlement would benefit the exchanges overall, it is also worth noting that OTC desks provide other services. Clients do want immediate execution sometimes and are willing to pay for OTC dealers to take on risk. In addition, many clients do not want to have to buy, build or manage systems such as CoinRoutes provides to trade across markets, and would, therefore use agents to access the markets on their behalf. That said, exchanges, as a group, would certainly regain market share if it were easier for clients to trade across multiple venues.
So, to conclude, there is only one Bitcoin, BUT, a “go it alone” attitude on the part of market participants is problematic. The Highlander made for a classic movie, and that attitude seems to work in Silicon Valley, but in financial markets, cooperation among competitors results in a better market overall.