Category Archives: liquidity

8/12/17: Coinbase to Bitcoin Flippers: You Might Flop


If you need to have a call to 'book profit', you are probably not a serious investor nor a seasoned trader. Then again, if you are 'into Bitcoin' you are probably neither anyway. Still, here is your call to "Go cash now!" https://blog.coinbase.com/please-invest-responsibly-an-important-message-from-the-coinbase-team-bf7f13a4b0b1?gi=f51a107183c9.

In simple terms, Coinbase is warning its customers that "access to Coinbase services may become degraded or unavailable during times of significant volatility or volume. This could result in the inability to buy or sell for periods of time." In other words, if there is a liquidity squeeze, there will be a liquidity squeeze.

Run.


So a couple of additions to this post, on foot of new stuff arriving.

One: Bloomberg-Businessweek report (https://www.bloomberg.com/news/articles/2017-12-08/the-bitcoin-whales-1-000-people-who-own-40-percent-of-the-market) that some 40% of the entire Bitcoin supply is held by roughly 1,000 'whales'. Good luck seeing through the concentration risk on top of the collusion risk when they get together trading.

Two: Someone suggested to me that ICOs holding Bitcoin as capital reserves post-raising are part problem in the current markets because by withdrawing coins from trading, they are reducing liquidity. Which is not exactly what is happening.

Suppose an ICO buys or raises Bitcoins and holds these as a reserve. The supply of Bitcoin to the market is reduced, while demand for Bitcoins rises. This feeds into rising bid-ask spreads as more buyers are now chasing fewer coins with an intention to buy. Liquidity improves for the sellers of the coins and deteriorates for the buyers. Now, suppose there is a sizeable correction to the downside in Bitcoin price. ICOs are now having a choice - quickly sell Bitcoin to lock in some capital they raised or ride the rollercoaster in hope things will revert back to the rising price trend. Some will choose the first option, others might try to sit out. Those ICOs that opt to sell will be selling into a falling market, increasing supply of coins just as demand turns the other way. Liquidity for sellers will deteriorate. Prices will continue to fall. This cascade will prompt more ICOs to liquidate Bitcoins they hold, driving liquidity down even more. Along the falling prices trend, all sellers will pay higher trading costs, sustaining even more losses. Worse, as exchanges struggle to cover trades, liquidity will rapidly evaporate for sellers.

It is anybody's guess if liquidity crunch turns into a crisis. My bet - it will, because in quite simple terms, Bitcoin is already relatively illiquid: it takes hours to sell and spreads on trading are wide or more accurately, wild. Security of trading is questionable, as we have recently seen with https://www.fastcompany.com/40505199/bitcoin-heist-adds-77-million-to-hacked-hauls-of-15-billion, and the market is full of speculation that some of these 'heists' are insider jobs with some exchanges acting as pumps to suck coins out of clients' wallets. The rumours might be total conspiracy theory, but conspiracy theories turn out to be material in market panics.

1/12/17: Eonia’s strange vaulting


What concentration risk and liquidity risk can do to you when both combine?


Eonia (Euro OverNight Index Average) is the 1-day interbank interest rate for the Euro zone. In other words, it is the rate at which banks provide loans to each other with a duration of 1 day (so Eonia can be considered as the 1 day Euribor rate). In other words, it is a measure of short-term liquidity.  Eonia is an average of actual rates charged, so it is, in theory, a reflection of the market demand for short term liquidity. But Eonia is a tiny market, trading normally daily at around EUR7 billion or less. And in a tiny market, there can be a sudden shift in trading volumes. This is what happened on Wednesday and Thursday. Eonia rose from -0.36 basis points on Tuesday to -0.30 bps on Wednesday to -0.24 bps on Thursday.

Eoinia's volumes are 90% direct borrowing by prime banks (and the balance is brokered), so a handful of large institutions use the market to any significant extent. Which induces concentration risk. Worse, Eonia is a secondary/supplementary market, because the ECB currently provides extremely cheap liquidity in unlimited volumes on a weekly basis. Which is another risk to Eonia, as it is thus set to absorb any short term variation in liquidity demand (below 1 week).

Bloomberg speculated that "The most likely explanation is a technical hitch, rather than some sudden crisis warning. The cause of the spike could be a U.S. financial institution that has switched its year-end accounting period from Dec. 31 to Nov. 30. This may have driven a sudden need for short-term liquidity, thereby causing a squeeze. It was month-end for many financial institutions on Thursday, on top of which we are approaching year-end periods, when cash and collateral rates often get squeezed. A bit of indigestion shouldn’t be a surprise. But a move this big is."

If Friday close gets us back toward Tuesday opening levels, the glitch might just be a glitch. If not, something might be happening beyond 'technical' hitches.

The strangest bit is that the move signals a potential liquidity squeeze in a market that has, if anything. too much liquidity. And the matters are not helped by the shallow trading volumes, that imply a concentrated move.

Something to watch, folks, if anything - for just another illustration of the concept of correlated risks.

10/1/16: Tsallis Entropy: Do the Market Size and Liquidity Matter?


Updated version of our paper:
Gurdgiev, Constantin and Harte, Gerard, Tsallis Entropy: Do the Market Size and Liquidity Matter? (January 10, 2016), is now available at SSRN: http://ssrn.com/abstract=2507977.


Abstract:      
One of the key assumptions in financial markets analysis is that of normally distributed returns and market efficiency. Both of these assumptions have been extensively challenged in the literature. In the present paper, we examine returns for a number of FTSE 100 and AIM stocks and indices based on maximising the Tsallis entropy. This framework allows us to show how the distributions evolve and scale over time. Classical theory dictates that if markets are efficient then the time variant parameter of the Tsallis distribution should scale with a power equal to 1, or normal diffusion. We find that for the majority of securities and indices examined, the Tsallis time variant parameter is scaled with super diffusion of greater than 1. We further evaluated the fractal dimensions and Hurst exponents and found that a fractal relationship exists between main equity indices and their components.