Tuesday, December 19, 2017

"Why you can’t cash out pt 1: Why Bitcoin’s “price” is largely fictional"

From David Gerard:
Public discussion and media coverage of Bitcoin makes certain assumptions:
  • Bitcoin has a price, that you could expect to buy or sell it around.
  • Bitcoin is like buying a share in a company, or a commodity like gold —  the market works the same way.
  • Bitcoin is liquid — it’s reasonably easy to convert your money to Bitcoin, and your Bitcoin to money in your bank account.
None of these are true.
How much is a bitcoin worth?

I’m looking at the CoinDesk Bitcoin Price Index. At this moment, it says $19699.46. Whoops, it’s $19691.76! Now it’s $19690.70! And so on.

This number is marketing for Bitcoin. It’s meant to give the impression that Bitcoin is a solid tradeable object with an orderly market structure, that you can meaningfully price it down to the cent, and that all this is fine and sensible. But this is an illusion.
The singular “price” of Bitcoin doesn’t exist — it’s a made-up number. It’s not a number you could expect to exchange a bitcoin for — it’s an average of the last sale price on a bunch of exchanges. (CoinDesk’s index uses Coinbase, Bitstamp, itBit and Bitfinex. Followers of crypto will have just exclaimed “what!” at that last one.)
If you look at the spread between exchanges — the different prices for one interchangeable bitcoin — you’ll see spreads of hundreds of dollars, and in volatile moments it can be in the thousands.
Quoting a number like “$19699.46” to seven significant figures when your data’s got a 5% spread would get your high school physics teacher slapping you upside the head. It’s entirely deceptive. It should say something like “$19,700 plus or minus $500 depending,” and that line graph should be a thick grey bar.

“Market cap” is even worse. It’s literally just whatever the last price was, multiplied by the number of tokens in existence. This is a bogus number that’s not actually applicable to anything — it’s not money that was put into the crypto, it’s not a realisable value like a company market cap, it doesn’t affect prices — it’s just an easily-calculated splashy-looking number that looks good in a headline. Trading is so thin in any crypto, even Bitcoin, that you could never realise a fraction of the number. It is literally just marketing.

Why is Bitcoin like this, though? Why isn’t the price a reasonably usable number?

Isolated islands, posing as a continent
(This section cribs from Paulo Santos‘ excellent article “Bitcoin Series Addendum — Market Structure”, which you should log into and read in full so he gets paid.)

In normal securities trading, if a share is listed on multiple exchanges, orders will often be applied via smart order routing — so that a given buy or sell order is in the context of all the order books for that stock. This avoids liquidity fragmentation — where the various exchanges’ order books are unnecessarily isolated from each other, making each a separate trading pool, thus more volatile and harder to trade in. This is easy because, unlike bitcoins on exchanges, the actual exchanges don’t need to hold the stock for a trade to happen.

This doesn’t work in Bitcoin — all trading is isolated on each individual exchange, and the bitcoins are actually there on the exchange. This is a recipe for huge volatility and wide discrepancies in price....

HT: FT Alphaville's Further Reading post

Previously from Mr. Gerard:
"ICO of the day: Synthetic rhino horn erection pills, on the Blockchain"