{"id":790,"date":"2018-06-11T18:05:41","date_gmt":"2018-06-11T18:05:41","guid":{"rendered":"https:\/\/securitycurve.com\/?p=790"},"modified":"2018-06-11T18:05:41","modified_gmt":"2018-06-11T18:05:41","slug":"coinrail-cftc-and-cryptocurrency-liquidity","status":"publish","type":"post","link":"https:\/\/securitycurve.com\/?p=790","title":{"rendered":"Coinrail, CFTC, and cryptocurrency liquidity"},"content":{"rendered":"

\"\"<\/a>Cryptocurrency prices are down in the wake of the recent Coinrail hack<\/a> — it’s worth a read, but in a dance we’ve all been through before, Coinrail announced<\/a> that they were the victim of a hack whereby the bad guys made off with about 30% of their reserves.\u00a0 And, as you might surmise, the selloff begins<\/a>.<\/p>\n

So that’s not good.<\/p>\n

I was putting together a few thoughts about this for press inquiries this morning, and since a longish analysis doesn’t always do great in a “soundbite” format, I figured I’d pass along a few thoughts here to explain in more detail a few things that I think are going on, why I think they’re noteworthy, and a few implications that I think the cryptocurrency community as a whole needs to fix.<\/p>\n

The background on this is that almost every cryptocurrency is down in the wake of the Coinrail thing.\u00a0 It’s obvious and it freaks people out, but it isn’t exactly a surprise: we saw it with the Mt. Gox meltdown<\/a>, we saw it with DAO hack<\/a>, etc. etc.\u00a0 But this one is I think a little different.\u00a0 It’s impacting all currencies at the same time, not just the ones that were lost by Coinrail.\u00a0 It’s also, percentage-wise, fairly significant relative to previous fallout (excepting of course the immediate liquidity-related BTC price drop that happened in June 2011<\/a>\u00a0as a result of the Mt. Gox situation).\u00a0 I think the dynamics here are interesting, I think there are a few salient points that are impacting the situation immediately, and I think there are a few long-term implications.\u00a0 I’ll go through point by point and then spell out the broader implication(s):<\/p>\n

    \n
  1. The weak point is the exchange<\/strong> – as we all know, the difference between cryptocurrencies and fiat currencies are that they are designed to be free from direct control from a political power like a government or whatever leaving that role open instead to Bitmain…<\/del><\/a>\u00a0 Because of this, people tend to assume that the problems that impact other currencies – like for example price manipulation and so forth – don’t apply.\u00a0 That might be true if: a) it operated like a currency and b) it was used the way it was envisioned to buy goods and services.\u00a0 But as we know, neither of those things are true.\u00a0 Instead, cryptocurrencies behave like commodities, derivatives, or securities.\u00a0 Why?\u00a0 Because people don’t buy a cryptocurrency to spend it — they buy it to speculate.\u00a0 This in turn means that, unlike other currencies which are by definition liquid, cryptocurrencies are instead subject to the rules of liquidity (because the “benchmark” – what they ultimately care about – is their native currency, not the cryptocurrency).\u00a0 And, the corollary to that is that the more people speculate, the more important liquidity becomes.\u00a0 Because, like, people want to be able to get their money back in whatever fiat currency they happen to care about.\u00a0 This means in essence that any\u00a0market-making<\/a>\u00a0 going on is done by the exchanges.\u00a0 This is a true fact.\u00a0 In a bull market they make money on arbitrage<\/a> in addition to transaction fees.\u00a0 So in a bull market, they’re serving as essentially market makers — but the reverse isn’t true.\u00a0 Under bear conditions, what’s their incentive to buy?\u00a0 Anyone? Anyone?\u00a0 Bueller?\u00a0 Exactly none.\u00a0 Because taking on market risk isn’t their business — exchanging currency is.\u00a0 So, “exchanges = liquidity” for cryptocurrency… and exchanges make the market only when Taurus is rising (get it?\u00a0 Because it’s a bull… nevermind.)\u00a0 This might seem like an academic point at this point, but I’ll get back to it in a minute.<\/li>\n
  2. Confidence is down already<\/strong> – You maybe didn’t notice, but the CFTC is investigating the largest exchanges for price manipulation<\/a>.\u00a0 Friggin’ finally.\u00a0 The tl;dr on this is that the CFTC regulates commodities in the US<\/a>, they’ve decided that cryptocurrency behaves enough like a commodity that they should be the one regulating it (they’re right by the way.)\u00a0 They’ve also apparently been paying attention to a bunch of us that have been calling “shenanigans” on price manipulation for years now.\u00a0 I don’t think it’s limited to exchanges, but since they’re the ones that are in the best position to capitalize on it, I get why they’d start there.\u00a0 Ultimately, this is a good thing (and about damn time), but in the short term it erodes confidence.<\/li>\n
  3. It’s a bubble<\/strong> – sorry, it is.<\/li>\n<\/ol>\n

    So the upshot is that: a) confidence is down because of the attack, b) confidence is down because of the investigation, c) a correction is due, and d) price fluctuations are exaggerated because of lack of liquidity (or more specifically “unregulated pseudo-market-making by exchanges”->”liquidity only in bull conditions”->”illusory liquidity”->”illiquidity”).<\/p>\n

    What’s my point?\u00a0 There are two implications of this that it is important I think to pay attention to.\u00a0 First, we should probably all know by now that cryptocurrency, just like any other currency, only has value to the extent people believe it does.\u00a0 That’s an obvious truism of course (nihil sub sole novum est<\/em>), but it’s useful to point out because it means that confidence in the currency will impact price positively or negatively.\u00a0 Because of course it does.\u00a0 And volatility occurring as a result of this will be amplified as long as #3 is true.<\/p>\n

    All that would be OK if there was a reliable source of liquidity like there is for everything else that people speculate in (OK, so maybe less so recently<\/a> but still).\u00a0 Since liquidity in cryptocurrency is bogus until and unless there’s a market maker, this means that downward pressures on price will be exaggerated as buyers < sellers.\u00a0 So the question of the day becomes, is the role of an exchange the same as a market-maker?\u00a0 Should it be?<\/p>\n

    If, like me, you think the answer to that is “no”, then we as a community (i.e. the folks interested in and optimistic about cryptocurrency) need to do something to fix this.\u00a0 The most obvious answer is to introduce a market maker.\u00a0 If I had a few hundred million dollars hanging around, this is the kind of business I would absolutely start.\u00a0 But I don’t… Maybe somebody else does.<\/p>\n

    Another answer is of course to counterbalance speculators with people using the currency as… well, currency.\u00a0 Easier said than done.\u00a0\u00a0In an ideal world, I’d have that be a credit card.\u00a0 What do I mean?\u00a0 Say there was a credit card that someone in the community could buy that used as a “native currency” whatever cryptocurrency they want.\u00a0 Let’s say ETH (because I happen to like ETH).\u00a0 What if that card offered a decent exchange rate between other currencies and ETH the same way they do for US cardholders making a purchase in Europe?\u00a0 The card issuer does the conversion on the backend so it’s invisible for the cardholder.\u00a0 Each cardholder in that world gets to support their currency of choice, it’s a win for the bank (both in marketing and of course new cardholders), and it’s a win for the community by virtue of a new “frictionless” source of liquidity.\u00a0 Seems to me like everybody wins.<\/p>\n","protected":false},"excerpt":{"rendered":"

    Cryptocurrency prices are down in the wake of the recent Coinrail hack — it’s worth a read, but in a dance we’ve all been through before, Coinrail announced that they were the victim of a hack whereby the bad guys made off with about 30% of their reserves.\u00a0 And, as you might surmise, the selloff […]<\/p>\n","protected":false},"author":1,"featured_media":0,"comment_status":"open","ping_status":"open","sticky":false,"template":"","format":"standard","meta":{"_et_pb_use_builder":"","_et_pb_old_content":"","_et_gb_content_width":"","footnotes":""},"categories":[4],"tags":[27,28],"class_list":["post-790","post","type-post","status-publish","format-standard","hentry","category-security","tag-coinrail","tag-cryptocurrency"],"_links":{"self":[{"href":"https:\/\/securitycurve.com\/index.php?rest_route=\/wp\/v2\/posts\/790","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/securitycurve.com\/index.php?rest_route=\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/securitycurve.com\/index.php?rest_route=\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/securitycurve.com\/index.php?rest_route=\/wp\/v2\/users\/1"}],"replies":[{"embeddable":true,"href":"https:\/\/securitycurve.com\/index.php?rest_route=%2Fwp%2Fv2%2Fcomments&post=790"}],"version-history":[{"count":0,"href":"https:\/\/securitycurve.com\/index.php?rest_route=\/wp\/v2\/posts\/790\/revisions"}],"wp:attachment":[{"href":"https:\/\/securitycurve.com\/index.php?rest_route=%2Fwp%2Fv2%2Fmedia&parent=790"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/securitycurve.com\/index.php?rest_route=%2Fwp%2Fv2%2Fcategories&post=790"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/securitycurve.com\/index.php?rest_route=%2Fwp%2Fv2%2Ftags&post=790"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}