Examination of Bitcoin liquidity, price discovery and market place development

9 January 2020

Bitcoin’s rise to fame in late 2017 resulted in the rapid opening and expansion of exchanges worldwide, offering ways to enter and exit an underserved market that’s a global, round-the-clock, disconnected marketplace for a new and unconventional investment class.

Up until the cryptocurrency boom a little over two years ago, access was limited to select reputable exchanges, while many other venues were the target of major security breaches from hackers looking to steal from the exchange itself or its users. Due to these hacks, as well as Bitcoin’s pseudonymity, exchanges were being labelled as a primary concern for money-laundering activities by regulators placing trading venues squarely between a rock and a hard place. This deterred the development of the high-grade trading tools akin to those seen in traditional and established exchanges.

But the asset class has come a long way in the past few years as media buzzed with headlines of extreme gains within a low yield financial reality of conventional assets, such as stocks and bonds.

Beyond price, Bitcoin has also been able to shed the negative halo around it and is now being closely observed for its intended purpose as a Store-of-Value (SoV) asset and means of payment. Both these characteristics, however, are facing an uphill battle as volatility hampers the attraction of a larger non-trading audience.

The payments use case has yet to find much appetite.

Bitcoin, as it stands, is no longer being voiced as a primary payments tool by the community, but as a replacement for gold in a digital format. In 2019, a huge marketing campaign was launched by Grayscale, a New York based cryptocurrency asset fund manager advising people to “drop gold” from their portfolios and replace it with Bitcoin.

Regardless of the ideological position one might take for the ultimate use case for the cryptocurrency, what has become evident is that Bitcoin has gained investment opportunity prominence.

This can be seen by the further establishment of regulator-approved products on institutional venues, marking its legitimate appearance on the trading stage. Legacy and new cryptocurrency exchanges have also had to adhere to a strict application of regulatory requirements, security tightening and even insurance coverage. This in-turn has eased regulatory approval for derivative products, ranging from cash and physically settled futures to Exchange Traded Products (ETP).

But despite the advancement seen recently, problems of liquidity are apparent.
High volatility rates have resulted in the deterioration of the trust that the cryptocurrency can act as a reliable SoV, though, investors have found the opportunity plentiful.

This high volatility points only in the direction of liquidity, or lack thereof. As a result, Bitcoin, despite massive growth in trading activity, continues to see extreme price swings in both directions as trading venue liquidity gets squeezed.

This report will examine the multiple aspects affecting price discovery, market development and the relationship between volatility and liquidity based on trading volumes across regulated and reputable exchanges under a macro and micro lens.

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