Companies  •  Data Analysis  •  Exchanges  •  Features

Why Some Bitcoin Exchanges Might Die in 2015

(@dannybradbury) | Published on January 3, 2015 at 16:54 BST

The recent levelling out of bitcoin’s price volatility might be good news for everyday bitcoin users, but could it send a bunch of exchanges off the cliff?

CoinDesk recently spoke to the CEO of a company whose fortune depends on the health of bitcoin exchanges. In the off-record conversation, the exec had something disturbing to say: bitcoin’s falling volatility is causing problems for exchanges, which rely on volatility for trading volume. Without trading volume, their revenues will fall, leading to a shakeout in 2015.

That’s scary stuff, but does it hold up? Let’s start with the link between volatility and volume.

Volatility means volume

“Volatility is positively correlated to trading volume in all markets, not just the bitcoin market,” said Jaron Lukasiewicz, CEO of New York-based exchange Coinsetter. “This is not a unique characteristic of our space, but rather a fundamental tendency of trading in general.”

Others have numbers to back that up. Joseph Lee, CEO of bitcoin derivatives platform BTC.sx, took daily highs and lows from Bitstamp’s trading data, and used it to calculate the variation from the day’s weighted price.

BitStamp Volatility vs Volume

“What we see very transparently is the direct correlation between price movement (volatility) and trading volume. This remains true across all exchanges in this space,” he said.

Jeremy Glaros, CEO of Coinarch, which offers bitcoin-based derivatives, found similar results. He mapped intra-day price ranges at several exchanges against total market volumes and found a strong link.

He said:

“The statistical relationship looks quite strong, with an R-squared value of 75%. One hundred percent would imply that the volatility completely explains volume and 0% would say it has nothing to do with it at all.”

Volatility and exchanges

So, volatility does equal volume. But is volatility really shrinking? Over at the Bitcoin Volatility Index, we can see volatility at relative lows from May 2014, when compared to bitcoin’s history from late in 2010.

Bitcoin Volatility

Eli Dourado, a research fellow at George Mason University’s Mercatus Center, created the Volatility Index. He offered this theory as to why volatility has slipped:

“Bitcoin volatility has gone down because of the growing ecosystem. There are more sophisticated players who are doing more hedging and providing more liquidity to the market.”

Generally speaking, exchanges love volatility, said Gerald Cotten, CEO of Vancouver-based exchange QuadrigaCX. Conversely, things are harder for them when the prices paddle in the shallows.

“Large price swings in either direction typically result in higher trading volumes on exchanges, and therefore higher profits,” Cotten said. “When the price is flat, the total volume traded is definitely lower, which does have a negative impact on profits.”

Does this mean that revenue is going to plummet for exchanges if this continues?

That depends on a few factors, experts suggest. One of them is where the exchanges are based, according to BTC.SX’s Lee. Typically, exchanges that make their money from trading fees of between 0.1% and 0.6%, he said, making it relatively easy to calculate their profitability.

“The exchanges based out of China prefer a revenue model of 0% fees on trading volume, but instead charge on deposits and withdrawals,” he said. “The correlation in these cases may not be as direct. Profit figures in these cases would be more difficult to ascertain.”

Not all exchanges are equal

An exchange’s fortunes in the light of bitcoin volatility also depend on the services that it offers. Charles Hoskinson, former CEO of the Ethereum decentralised application platform and developer of an Udemy online course on bitcoin, argues that exchanges have recourse to many mitigation options.

“It depends on products that exchanges are offering,” he said. “What about bitcoin to ripple, or to litecoin, or doge? Those things exist still and there are value-added features in exchange models. You can diversify to stay relevant.”

Altcoins are a high-margin area of trade, Hoskinson suggested. There are some exchanges, such as Vault of Satoshi, that have been aggressive with altcoin trading services.

The diversification options don’t just stop with altcoins, though.

“We’ve noticed that stability brings the opportunity to increase profits in other areas of our business,” said QuadrigaCX’s Cotten. “For example, we offer merchant services that are basically like BitPay's, but more focused on the Canadian market. When volatility cools down, we usually see a higher volume of merchant transactions.”

The other option is to offer derivatives, which can increase the complexity and depth of the market and offer more hedging opportunities. However, Hoskinson points to a tight regulatory environment as a barrier here.

So, whether or not there’s a shakeout in exchanges depends on several factors. Clearly, how stable bitcoin’s prices remain in the future will be one of them. Secondly, how much they hedge risk by diversifying their revenue models will be another.

Natural selection

Perhaps some exchanges should go, suggests CoinArch’s Glaros. “Some competition is good to be sure, but a highly fragmented market like this risks more defaults and more bad actors, which is I think bad for users overall,” he said.

Hoskinson argues that too fragmented a market can damage intra-exchange liquidity by dividing too few traders among too many exchanges.

If there is a shakeout, then there may be some good to come of it, suggests Dourado.

“Even if the reduction in volatility is bad for bitcoin as a speculative asset, it’s good for bitcoin as a currency,” he concluded. “Exchanges might gain business because of wider bitcoin adoption, even though they’re losing business from speculative trading now.”

Bitcoin’s volatility could spike tomorrow, of course, which would give exchanges with narrowly focused service and revenue models a welcome shot in the arm.

In case it doesn’t, though, wouldn’t it be sensible to hedge the risk and create a broader portfolio of services?

Disclaimer: The views expressed in this article are those of the author and do not necessarily represent the views of, and should not be attributed to, CoinDesk.

Closed sign image via Shutterstock

ExchangesPricesVolatility

Load Comments