The market quality provided by crypto trading venues decreases with the aggregate blockchain computing power (the ‘mining power’) supplied by the miners, according to the first empirical study analysing the relationship between the mining power and the market quality offered by crypto trading platforms, published by the World Federation of Exchanges (WFE).
Cryptocurrencies offer diversification benefits for investors, particularly those with short investment horizons. However, the new WFE Research Working Paper, titled “Blockchain mining power and market quality in cryptocurrency”, finds that the trading quality offered by blockchain-based crypto platforms is negatively correlated with the quality of the market, falling short of the fairness and well-functioning services offered by established exchanges. This aspect of the crypto markets has thus far been overlooked by stakeholders.
The WFE Research paper considers historical intraday data and analyses the behaviour of three cryptocurrencies (Bitcoin, Ether, and Litecoin) across three distinct crypto trading platforms (Coinbase, FTX, and Kraken) from January to June 2021. Using these data, it measures the correlations between changes in the blockchain’s aggregate hashrate (a measure of mining speed) and different measures of market efficiency and liquidity.
The market quality provided by these crypto-trading venues is related to the aggregate blockchain computing power supplied by the miners: when there is a decrease in mining power there are more pricing discrepancies and arbitrage opportunities, and liquidity is reduced. Efficient pricing is therefore undermined by the operational design of the market.
The WFE paper concludes that, since mining power is not in the control of either the trading service providers or the regulators, the onus is on investors and other stakeholders to consider this distinctive characteristic of blockchain technology when trading crypto assets.
Nandini Sukumar, CEO at the WFE, said: “Crypto trading offers an alternative investment route and method of portfolio diversification. The sector is inherently different to exchanges, both operationally and from a regulatory perspective, and must be viewed as so. Crypto will become more prevalent as a trading strategy as the market grows and comes onto regulated exchanges. This intensifies the need to ensure awareness of market quality considerations so investors understand the difference in trading dynamic from what they get on exchanges.”
Pedro Gurrola-Perez, Head of Research at the WFE said: “Despite the flow of capital into crypto assets, the benefits and drawbacks of this asset class are not well understood by all market participants. This first-of-its-kind study underscores the importance of designing fair and efficient markets for cryptocurrencies and protecting investors.”
The WFE Research team will present the paper and discuss its findings in a webinar on 21st November 2023 at 3pm GMT. To register, please click here:
https://worldfederationofexchanges.webex.com/weblink/register/rf00052bafe5172139be2349c1e7907cb
You can download the full report here.
