Crypto Trading
Instructors: Andreas Park & Zissis Poulos
DeFi Overview
Overview of Traditional Trading
A glimpse of overall infrastructure
Sue wants to sell ABX
Bob wants to buy ABX
sell order
buy order
Clearing House
Stock Exchange
Broker
Broker
3rd party tech
custodian
custodian
record beneficial ownership
central bank for payment
Types of traders
Trading in Equity Markets today
Retail
Institutional
Pro-Traders
high volume securities
low volume securities
50%
50-60%
0%
30-40%
40-50%
10-20%
Summary of workflow
Exchange
Traditional
Internalizer
Wholeseller
Darkpool
Investor
Venue
Broker
Settlement
Exchanges
Wholesellers
Dark pools
Broker Internalizations
Where does trading occur?
Trading in Equity Markets today
Exchanges
Wholesellers
Dark pools
Broker Internalizations
How does trading work?
Trading in Equity Markets today
(
(
How to access the market?
Trading in Equity Markets today
Retail
Institutional
Pro-Traders
Retail: Canada
Trading in Equity Markets today
Rule: must send to exchange with best price
Retail: U.S.A.
Trading in Equity Markets today
Exchange
Wholeseller
market order
limit order
In Europe: no best price obligation
Institutions: U.S.A.
Trading in Equity Markets today
Exchange
Dark pools
Pro Traders
Trading in Equity Markets today
Type 2: "borrow" broker-dealer system
Type 1: licenced broker-dealer
risk control
Big Message
Trading in Equity Markets today
-
You commonly don't access the market directly.
-
Brokers take many decisions but they are bound by regulations.
-
Critical: markets are formally linked by best-price rules.
Crypto Trading Overview
Three Fallacies for Crypto Economics
crypto assets = traditional equities
crypto trading = traditional trading
crypto entities = traditional firms
Types of traders
Trading in Equity Markets today
Retail
Institutional
Pro-Traders
high volume securities
low volume securities
50%
50-60%
0%
30-40%
40-50%
10-20%
Coinbase's recent numbers
Coinbase's recent numbers
Summary of workflow
Crypto
Investor
Venue
Settlement
On chain
Types of traders
Trading in Crypto Markets
Retail, Institutions, and Pro-Traders are indistiguishable
not clear whether and which institutions are active
Where does trading occur?
Trading in Crypto Markets
Exchanges
Dark pools
Smart On-chain contracts
Exchanges
Smart Contract
How does trading work?
Trading in Crypto Markets
Order Driven
Market Maker
How do you access the market?
Trading in Crypto Markets
Exchanges
Smart On-chain contracts
Within exchange operation
Trading in Crypto Markets
trade
lend
Settlement
Trading in Crypto Markets
trade
Fully decentralized 1.0
... 300 lines of code ...
Some Stylized Facts on Crypto Trading
How many CEXes are there?
(307 CEX, rest DEX)
What are the differences?
What do they trade?
Link to traditional finance?
- spot trading
- derivatives
- crypto-only
- "fiat" linked
- regulation
- cryptos traded
- accessibility
- privacy
- credibility
Concerns with CEX-Trading
Concerns
arbitrage is either not possible or requires large capital commitment => expensive
exchanges = brokers? => single point of failure
decentralized: totally anonymous => easy price manipulation (e.g. wash trades)
Bitcoin prices in USD, May 25 2018, 17 exchanges
Arbitrage?
Pre-req for Trading on a Crypto Exchange
trade
Settle on the blockchain for digital "assets"
Wire transfer for fiat
Arbitrage on a Crypto Exchange
BTC/USD
ask: 7,600
bid: 7,550
BTC/USD
ask: 7,500
bid: 7,450
buy low
sell high
Arbitrage on a Crypto Exchange
BTC/USD
ask: 7,600
bid: 7,550
BTC/USD
ask: 7,500
bid: 7,450
buy BTC
sell BTC
move BTC to Kraken
=> arbitrage = commit capital on multiple exchanges
Arbitrage on a Crypto Exchange
Wire: free*; 1-5 days
Credit card: 3.5%
trading fee: 10-25 bps
flat fee in BTC \(\approx\) $4-8
\(\approx\) 10-60 minutes
trading fee: 0-26 bps
35 USD + 0.125%
($5 if >$50,000)
1-3 business days;
possible other fees/delays
Some exchanges allow short selling
Crypto Wash Trading, Lin William Cong, Xi Li, Ke Tang, Yang Yang
- systematic tests:
- robust statistical and behavioral patterns in trading to detect fake transactions on 29 cryptocurrency exchanges.
- Regulated exchanges are OK
- unregulated exchanges: rampant manipulations
- wash trading on each unregulated exchange:
- on average over 70% of the reported volume
- improve exchange ranking
- temporarily distort prices
Volume Manipulation on Crypto Exchanges
Cryptocurrency Pump-and-Dump Schemes
Tao Li, Donghwa Shin, and Baolian Wang, 2020
What is pump and dump?
arranged via Telegram Channels
Price Manipulation on Crypto Exchanges
- prices of pumped cryptocurrencies begin rising five minutes before a P&D starts.
- some pump group organizers offer premium memberships to allow certain investors to receive pump signals before others do (\(\to\) insiders)
- Average P&D insiders make one Bitcoin (about $10,000) in profit
- only investors who buy in the first 20 seconds after a P&D begins make a profit
Other Tidbits of Information
IS BITCOIN REALLY UN-TETHERED? JOHN M. GRIFFIN and AMIN SHAMS
Journal of Finance 2020
- basic idea: USDT is issued unbacked to trade Bitcoin and to inflate its price
- more on the next slides...
Price Manipulation on Crypto Exchanges
What's the result?
Regulated Exchanges
Derivatives trade mostly offshore! Unregulated(?!)
- on April 30, 2019: Tether does not have cash reserves equal to 100% of the outstanding Tethers.
- May 15, 2019 court hearing: Tether did invest in instruments beyond cash, including Bitcoin
Historically: “Tether Platform currencies are 100% backed by actual fiat currency
assets in our reserve account.”
Today: "The Tether Platform is fully reserved when the sum of all tethers in circulation is less than or equal to the value of our reserves."
IS BITCOIN REALLY UN-TETHERED?
JOHN M. GRIFFIN and AMIN SHAMS
Journal of Finance 2020
vs.
Why does that matter?
- Tether = ‘pushed’
- print an unbacked digital dollar to purchase Bitcoin.
- \(\to\) additional supply of Tether creates unwarranted inflation in Bitcoin price
Text
IS BITCOIN REALLY UN-TETHERED?
JOHN M. GRIFFIN and AMIN SHAMS
Journal of Finance 2020
vs.
- Tether = ‘pulled’
- driven by legitimate demand from investors who use Tether as a medium of exchange
- \(\to\) the price impact of Tether reflects natural market demand
Text
IS BITCOIN REALLY UN-TETHERED?
JOHN M. GRIFFIN and AMIN SHAMS
Journal of Finance 2020
Flow of events
- Tether is authorized
- moved to Bitfinex
- then slowly distributed to other Tether-based exchanges (Poloniex and Bittrex)
- \(\to\) almost no Tether returns to the Tether issuer to be redeemed
- Kraken (major exchange for Tether\(\to\) USD) accounts for only a small proportion of transactions
Figure 1. Aggregate Flow of Tether between Major Addresses
Figure 3. Aggregate Flow of Bitcoin between Major Addresses.
Top Accounts Associated with the Flow of Tether from and Bitcoin to Bitfinex
- three main Tether exchanges, Bitfinex, Poloniex, and Bittrex, have considerable cross-exchange Bitcoin flows
- cross-exchange Bitcoin flows on Bitcoin closely match Tether flows
- one large player has >50% of the exchange of Tether for
- Bitcoin at Bitfinex
- \(\to\) distribution of Tether into market from ONE large player and not many different investors
If Tether is printed independently
of demand and pushed onto the market then ...
- \(\nearrow\) money supply in crypto
- \(\nearrow\) cryptocurrency prices through artificial demand
- if traded strategically, Tether can further impact and manipulate Bitcoin prices
the 1% of hours with the strongest lagged Tether flow are associated with 58.8% of the Bitcoin buy-and-hold return over the period.
Is the Price Effect Economically Important?
the "normal-times" returns
Crypto exchanges are a security risk
August 2016
Crypto exchanges are a security risk
By yours truly, Dec 2017: "What really concerns me about the current craziness is the role of the cryptocurrency exchange platforms, such as Coinbase, Quadriga, or Bitfinex, which most people use to buy Bitcoins. These are like banks that hold deposits. For cryptocurrencies to succeed it is critical that these interfaces with the real world are financially robust. Are they? Do they have all the Bitcoins they sell? Can they always satisfy depositors’ demands?"
Crypto exchanges are a security risk
https://www.forbes.com/sites/jasonbrett/2019/12/19/congress-considers-federal-crypto-regulators-in-new-cryptocurrency-act-of-2020/#7ddcdfd65fcd
Crypto exchanges are a security risk
https://www.osc.ca/en/news-events/news/osc-working-ensure-crypto-asset-trading-platforms-comply-securities-law
SEC denies Bitcoin ETF
How about fully decentralized trading?
Spirit of Blockchain: Fully decentralized
... 300 lines of code ...
standard trading rules practically impossible to enforce
Spirit of Blockchain: Fully decentralized
Actually ...
- bad idea
- Why?
- Data-intensive, computation intensive, costly, inefficient
How do you organize DEX trading?
Liquidity?
- Laissez-faire: Etherdelta or Kyber
- people submit contracts (limit orders) on-chain
- system collects info
- system offers "tools" to trade against standing contracts
- Hybrid: 0x
- "dark liquidity"
- off-chain/sidechain purchase/sale agreements
- system matches compatible orders and posts on-chain
- Automated market maker (AMM) (Uniswap)
- AMM holds assets on both sides
- offers two-sided quotes (\(\to\) always liquid)
- prices adjust continuously to demand/supply shifts
How should one organize DEX trading?
How do you set the price?
- Use an oracle
- Use a hard-coded function
the constant product pricing function
automated market maker
Price mechanism:
- \(X=\) contract balance of asset \(A\)
- \(Y=\) contract balance of asset \(B\)
- \(k=\) invariance factor
- key relation \(k=X\times\ Y\)
Prices
- when you want to sell \(x\le X\) you receive \(y\) that maintains invariance.
- implied exchange rate: \(e=\frac{x}{y}\)
- maintain constant product post trade: \[k=(X+x)(Y-y)~ \Leftrightarrow~y=\frac{xY}{X+x}.\]
How do you organize DEX trading? EXAMPLE
automated market maker
invariant \(k=4\times4=16\)
Instantaneous exchange rate:
1 = 1
Contract deposit:
How do you organize DEX trading? EXAMPLE
automated market maker
sell 4 DAI for USDC
what price will therefore be quoted?
how many USDC?
How do you organize DEX trading? EXAMPLE
automated market maker
Problem: large "slippage" (or price impact)
- imagine: deposit is 100 DAI & USDC:
- \(k=100\times100=10,000~\to\) for \(x=4\) need \(y=100-10000/104=3.85\)
- \(k=100\times100=10,000~\to\) for \(x=4\) need \(y=100-10000/104=3.85\)
-
imagine: deposit is 10,000 DAI & USDC:
-
\(k=10,000\times10,000=100,000,000~\to\) for \(x=4\) need \(y=10,000-100,000,000/10,004=3.998\)
-
\(k=10,000\times10,000=100,000,000~\to\) for \(x=4\) need \(y=10,000-100,000,000/10,004=3.998\)
- \(\to\) the more money is in the contracts, the lower the price impact
How do you organize DEX trading? other mechanisms
automated market maker
- anyone can become a liquidity provider when supplying both sides of a pair
- trades carry a fee of 30bps \(\to\) paid to liquidity providers (pooled)
- LPs still face opportunity costs relative to all other assets \(\to\) income must be sufficient
supercool feature
automated market maker
-
establish and sell a new token
- create token
- deposit token and counterasset (e.g., DAI)
- \(\to\) opening price
- \(\to\) new purchases will increase price
superannoying feature
automated market maker
-
front-running
-
transactions enter mem-pool
-
\(\to\) all visible there
-
arbitrageur make instant-swap trade at higher gas price
-
\(\to\) trade instead of original trade
-
\(\to\) reverse to gain slippage from earlier trader
-
-
front-running
"mem-pool"
1
2
4
3
5
6
1
2
5
3
6
7
4
So what?
-
front-running is annoying for the front-run - but will it happen?
- \(\to\) needs to be profitable!
- Problem: with constant product market makers it always is!
(modulo fees)
Some math
- front runner buys \(x\) and pays \(y\) when MM has \(X,Y\)
- front-run buys \(x\) and pays \(y^*\) when MM has \(X-x,Y+y\)
- front runner sells \(x\) and receives \(y^{**}\) when MM has \(X-2x,Y+y+y^*\)
\(\Rightarrow\) profitable!
Convenient feature for arbitrage: Flash loans (Flash swaps)
automated market maker
-
take three pairs (ignore that BTC is not directly on Ethereum)
-
BTC-DAI
-
ETH-BTC
-
ETH-DAI
-
- three pairs must satisfy non-arbitrage condition
- e.g. if ETH:DAI =1:100 and BTC:DAI=1:10000 then BTC:ETH=1:100
- say BTC:ETH=1:200 then
- borrow (say) 10,000 DAI
- use DAI to buy 1 BTC
- sell 1 BTC for 200 ETH and
- sell 200 ETH for 20000 DAI
- of which you use 10,000 DAI to repay loan and pocket 10,000
- Normally, this is hard!
- But on blockchain you can do all operations in one go
- \(\to\) no risk of leg of transaction not going through or non-delivery
- flash (single-block) loans enable this
How does it look?
automated market maker
\(\to\) simply connect with MetaMask (or similar wallet)
Concerns with DEX Trading
Problem: MEMPOOL Frontrunning is intrinsically profitable
\(X\)
\(Y\)
normal trade: sell \(x\) \(\to\) get \(y'\)
\(Y-y'\)
\(X+x\)
front-running:
- front-runner: sells \(x\) \(\to\) gets \(y'\)
- front-run: sells \(x\) \(\to\) gets \(y''\)
- front-runner: buys \(x\) \(\to\) pays \(y''\)
\(Y-y'-y''\)
\(X+2x\)
\(y'>y''~\Rightarrow\)
front-running is intrinsically profitable
Disclaimer:
- this problem is well-known
- fees can mitigate it
- several protocols such as the latest iteration by Balancer try to combat it
Some numbers (rounded to two decimals)
From Vitalik Buterin's post on the topic:
https://ethresear.ch/t/improving-front-running-resistance-of-x-y-k-market-makers/1281
- Suppose MMs have \((X,Y)=(10,10)\)
- Sell 1 of the \(A\) tokens; normally get \(.91\) \(B\) tokens.
-
\(\to\) front-runner goes first
- MM holdings: \((11,9.09)\)
-
\(\to\) front-run sells one \(A\( token, gets 0.76 units of \(B\)
- MM holdings: (12, 8.33)
-
Front-runner buys 1 unit of \(A\) pays 0.76 units of \(B\)
- profit: \(.91-0.76= 0.15\)
Mempool \(\Rightarrow\) Front-Running!
So what's the Problem?
a
b
c
d
e
f
g
Dark side of DEx trading: Miner extractable value
Summary
Summary of workflow
Crypto
Exchange
Traditional
Internalizer
Wholeseller
Darkpool
Investor
Venue
Broker
Settlement
Investor
Venue
Settlement
On chain
Main differences
Trading in Equity vs Crypto
- regulated environment
- firm trading rules
- listing requirements
- multi-step process
- complicated settlement
- many intermediaries
Equity Market
Crypto Market
- unregulated environment
- no trading rules - manipulation must be assumed
- single step process
- use of intermediaries is a choice
- crypto exchange are closer to brokerages than equity exchanges
- settlement a choice and straightforward
- fully decentralized trading is possible and most exiting innovation
- much work remains to be done
Copy of Topic 5: Crypto Trading
By zpoulos
Copy of Topic 5: Crypto Trading
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