14th February 2023 > > Adoption and arbitrage.

tl;dr

Some great crypto news, and a gentle warning about crypto arbitrage.

Market Snap

Market Wrap

Brian Armstrong, CEO and co-founder of Coinbase, has responded to fears that the SEC (Securities and Exchange Commission) will send a Wells notice to Coinbase alleging securities fraud by stating he is happy to go to court over the issue. The uncertainty is likely to weigh heavily on crypto prices for some time.

Curious Cryptos’ Commentary – Crypto adoption

Not exactly breaking news (I was still on the beach last week when Visa made this announcement which goes some way to explaining how I missed it) but very exciting news, nonetheless.

Visa has been in testing mode to accept USDC (USD circle a stablecoin) in exchange for fiat and paying out USDC in exchange for fiat.

Visa executive Cuy Sheffield revealed this development thus:

“That’s been one of the areas where we want to build muscle memory. The same way that we can convert between dollars in euros on a cross-border transaction, we should be able to convert between digital tokenized dollars and traditional dollars.”

He continued:

“We settle over Swift, so we can’t move money as frequently as we’d like because there are a number of limitations that exist in those networks. And so, we’ve been experimenting, we publicly announced, we’ve been testing how to actually accept settlement payments [with stablecoins].”

With 340 million card holders in the US, and 800 million in the rest of the world, this is – as Milk Road put it – “a BFD”, though I am unfamiliar with the F in that TLA.

There are many developing and emerging countries for whom foreign remittances can form an important element of the income for the local population. That income is currently subject to some outrageous fees. The World Bank estimated that a $200 remittance can incur costs ranging from 5% to 9.3% (https://www.un.org/development/desa/dspd/wp-content/uploads/sites/22/2020/01/World-Social-Report-2020-FullReport.pdf). Using stablecoins and crypto networks those fees can be reduced to mere cents or less.

This is a classic example of how cryptos will dramatically improve the lives of so many people, especially the poor and dispossessed, in the very near future.

Curious Cryptos’ Commentary – Crypto arbitrage

There are worrying signs that this new bull market we have just entered for cryptos is already being attacked by feral scammers (*) in ever greater numbers.

Tomorrow we will look in depth at what is an extraordinarily well constructed scam involving trading bots, and the advertising of those bots on social media sites such as Medium and YouTube.

In the meantime, I see ever more promotion of arbitrage strategies, which – though not all are outright scams – cannot possibly be grounded in arbitrage. They may work as correlation strategies, which sometimes have some legs to them, but the length of those legs is debatable. They involve many risks - the key point is that they are from being risk-free, which is the whole point of arbitrage.

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For those unfamiliar with this arcane subject the term arbitrage describes a concept of being able to buy an asset (any asset) at one price and instantaneously sell it for a higher price, without incurring any transaction fees, credit risk, operational risk, or settlement risk,

Clearly the arbitrage of physical assets is difficult.

Theoretically one could achieve it by owning any specific asset (for instance gold, oil, or wheat to name just three examples) in bulk on location at every spot marketplace globally. Then, if the price at one of those marketplaces went out of kilter and was too high, you would sell your wheat or whatever asset you are arbitraging in that marketplace and buy it back elsewhere for less cash.

On paper that could make you money, but the process involves tying up a lot of capital in owning stock in many different places, and government action worldwide right now is ramping up the cost of capital. You would also have storage costs prior to execution and transport costs (to replenish stocks elsewhere) once your arbitrage has been executed.

Taken in the round, I suggest that this would probably not be a successful investment strategy.

In parts of the financial world however, some of those problems are almost non-existent.

If you look at interest rate futures markets, there is no actual stock, there is no delivery, settlement costs are minimal to vanishingly small, all electronic exchange trades are reconciled instantaneously, and everything is cash collateralised at the end of every single trading day, allied with intra-day trade-by-trade monitoring of exposure with pre-determined and rigorously enforced credit limits.

What that means of course is that because one could get very close to a real arbitrage strategy across all the interest futures exchanges dotted around the world, those arbitrage opportunities simply cannot exist. For as soon as they could theoretically appear, someone would arbitrage them away, thus preventing them from happening in the first place.

As a side note, those of us of a certain age who know of the collapse of Barings Bank PLC due to the fraud perpetuated by Nick Leeson, will sagely nod their hands now in full agreement that the claims he made to be able to arb Nikkei futures was all just lies from start to finish.

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So, what does this mean for cryptos I hear you ask.

Though cryptos are undoubtedly a financial asset, they share a surprisingly large number of characteristics with physical goods.

If you want to arbitrage the price of BTC across different exchanges – and those opportunities undoubtedly exist – you need to own BTC at each of the exchanges you wish to arbitrage, which incurs both a capital cost and an opportunity cost, as DeFi (decentralised finance) takes a hold not just in the ETH world but increasingly for BTC too.

There are execution costs for each trade (the exchange takes a small fee on every trade), and there are timing risks in terms of executing both sides of the trade at different exchanges.

After trading, there will be transport costs as you rebalance your holdings across exchanges.

This is why promoters of arbitrage schemes are being disingenuous at best with their claims. Correlation strategies, and all its attendant risks, is a far more accurate description of their activities.

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(*) Who are all also presumably physically deformed, friendless, and unfamiliar with the twin concepts of teeth brushing and showers.