Federal Reserve: Bitcoin is NOT really frictionless

[bitcoinmarkets]

see full web version here: http://www.bitcoinfuturesguide.com/bitcoin-blog/federal-reserve-price-differences-across-exchanges-show-that-bitcoin-is-not-really-frictionless



The New York branch of the Federal Reserve published a paper today called Is Bitcoin Really Frictionless. It digs into the prices of bitcoin on three major USD spot exchanges: Bitfinex, BTC-e, and Bitstamp. It's an overall interesting paper with some good analysis and graphs and appears to be a genuine attempt to investigate bitcoin price issues.

The main point of the paper is to analyze how and why bitcoin price on these three exchanges differs so much, and to state that bitcoin is not really frictionless in this sense. Some of the culprits they point to are volatility, using this graph as a starting point they see the relationship it has between price differentials:



The main reason why price differences would exist between two exchanges on a fungible commodity like bitcoin is that there are barriers to efficiently arbitraging, or profiting from these price differences.  Normally if Exchange A has a price at $400 and Exchange B has a price of $410, you can simply buy at A and sell at B and earn $10.  

However in practice there are issues in waiting for wire transfers, bitcoin confirmations and risking volatility in the meantime, as well as fees:



The authors did a good job of analyzing the raw empirical data, compiling interesting relationships since 2013 on the three exchanges in question:



They even dig into the issue of exchange risk to explain why BTC-e trades persistently at a discount:

EXCHANGE FAILURE OR FRAUD IS ANOTHER SOURCE OF RISK. EXCHANGE FAILURE IS NOT MERELY A THEORETICAL POSSIBILITY IN BITCOIN MARKETS—IT OCCURS REGULARLY. A STUDY IN 2013 REPORTED THAT EIGHTEEN OF THE FORTY BITCOIN EXCHANGES ANALYZED—ALMOST HALF—ULTIMATELY FAILED. MOST NOTABLE AMONG ALL BITCOIN EXCHANGE FAILURES IS THAT OFMT. GOX, AN EXCHANGE THAT ONCE COMMANDED THE LARGEST SHARE OF THE MARKET AND LOST ROUGHLY $460 MILLION WORTH OF ITS USERS’ BITCOIN TO HACKERS IN 2014. COUNTERPARTY RISK COULD HELP EXPLAIN THE CONSISTENT DISCOUNT REALIZED ON BTC-E. UNLIKE BITFINEX AND BITSTAMP, BTC-E DOES NOT PUBLISH THE LOCATION OF ITS OPERATIONS, AND LITTLE IS KNOWN ABOUT ITS OWNERS. SUCH OPACITY MAY DETER USERS FROM USING THE EXCHANGE FOR GREATER PERCEIVED PROBABILITY OF BANKRUPTCY, WHICH WOULD ENDANGER USERS’ ACCOUNTS, OR FRAUD. ​

In total it's an interesting and well done paper, considering they are researchers working at the Fed. It seems intellectually honest and the conclusions are not meant to disparage bitcoin but just investigate why arbitrageurs don't close the price differences between major Bitcoin spot exchanges.

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[odolvlobo]

It is interesting that they point to problems in the fiat currency system as a source of friction in the Bitcoin system.

Solution: abandon fiat currency

[gentlemand]

Indeed. Perhaps one day there'll be extensive all crypto closed loops. Then they can revisit it and reassess.

[tyz]

It is funny that the arguments of the article are actually partly contradictory when you read between the lines 

[Patatas]

Pretty thoughtful article.Its nice it see such paper's published which discusses bitcoin from commercial point of view instead of technical one.Though this might be taken as an disadvantage by the Reserves calling it Money Laundering.The way flowchart is represented makes it look like that.Instead of buy bitcoin at ask price,they should have added "earn bitcoins" or "own bitcoins".We are looking at a bigger picture here,not only as an digital asset but completely reinventing the  wheel.

[ATguy]

Im not a trader, but this image catch my attention.

Transfer Bitcoin about 30 minutes
Deposit Dollars 5-10 days for wire transfer $20 fee
Withdraw Dollars 3-7 business days for wire transfer 0.1% fee


So whats the reason to use the Dollars when its so slow and expensive? Maybe the last that keep the Dollars used is price stability I guess, but its only because so many use such slow and expensive payment method (at least for international money transfers).

[Meuh6879]

you don't trade in FIAT currency ... when you find a low fee exchange ... in Bitcoin.
You charge in the morning ... you withdraw at the end of the journey.

HIGH security, no cost to withdraw (if you trade 3-6 hours).

FIAT money is a relic ... only used to charge exchange (not to withdraw in trading view).

[BellaBitBit]

Well they went to a lot of work on this.  Great to have press from such a big source even though the title is not great.  At least they make a point to say that Fiat IS friction.

[alyssa85]

OP, great job summarizing the article.

I think the reason for the differences is only partly down to the difficulty sending fiat to the exchanges. The other part is that when you send BTC you have to wait for six confirmations and it takes at least an hour, by which time the price has moved against you.

I wonder what the result would have been if they'd done the same exercise for a currency like doge, which confirms in a few minutes. From my experience big price differences don't exist across exchanges for doge at all.

[knowhow]

Well its amazing to see such material related to the bitcoin exchanges ,its very curious how then opportunity to make easy income at bitcoin and put fiat delays on the wall do dont be able to make,well bitcoin is getting slow being exposed.