Noelle Acheson is a veteran of company analysis and CoinDesk’s director of research. The opinions expressed in this article are the author’s own and are not investment advice.
The following article originally appeared in Institutional Crypto by CoinDesk, a weekly newsletter focused on institutional investment in crypto assets. Sign up for free here.
Shuttered shops. Empty streets. Scant traffic. The world’s financial centers are increasingly looking like ghost cities. The world’s financial markets, on the other hand, are a frenzy of activity as dealers and traders try to ride the wild swings each headline and sentiment shift brings.
Yet, even though almost all trading is electronic these days, conducted behind sanitary screens, there is talk of shutting down markets for health reasons. The health in question is not just that of the traders and support staff involved.
Wild seesawing as we have been seeing this month in both traditional and crypto markets destroy wealth more often than they create it. At times the destruction can be truly threatening – at time of writing, the S&P 500 has lost over $3 trillion in value so far this month. And, as we saw in 2008, market losses can trigger a widespread economic meltdown that impacts upon the lives of people who had no idea they were inadvertent market participants.
It takes on a new meaning, however, when the threat is more than economic. As most of us retreat to safety (with a huge shout-out of appreciation for those who can’t), markets need to keep running.
Yet, sending market makers to work from home is not as simple as it sounds. Regulations require certain levels of supervision, time stamping, data privacy procedures and voice recording that cannot be replicated in a home office. And market surveillance and audits are not quite as reliable via a saturated home Wi-Fi. The Commodity Futures Trading Commission, Securities and Exchange Commission and FINRA have issued no-action relief notices exempting market operators from these rules while the pandemic lasts, but the full functioning of markets will not be “business as usual.” Market makers that are out of their comfort zone, either because of unstable infrastructure or unclear rules, may have less appetite to offer liquidity.
So for the health and safety of people and prices, should markets close?
Some notable financial influencers have argued in favor of doing so. CNBC’s Jim Cramer believes that closing until the virus peaks would stop company valuations from collapsing unnecessarily. Tech entrepreneur Max Levchin argues doing so would allow everyone to focus on staying safe without the distraction of collapsing 401(k)s. Even Treasury Secretary Steven Mnuchin has confirmed there have been talks about reducing opening hours.
Bloomberg’s John Authers, one of the more insightful and sober economists I follow, presents the case for closure as a data issue: There’s not much point in letting markets absorb and trade on data when the data that matters (the spread of the virus and its economic impact) is incomplete and unreliable.
Less drastic but similar measures are being implemented already. Several countries, including France, Italy, Spain and South Korea, have instituted full or partial short-selling bans. Some support the move as an acceptable compromise to more stringent measures. Others point out that banning short selling distorts price discovery and limits investors’ hedging opportunities. A 2012 paper by researchers at the Federal Reserve Bank of New York showed stocks subject to short-selling restrictions performed worse than those not so restricted.
What’s more, almost all traditional markets have an in-built closure mechanism anyway in the form of circuit breakers. In the U.S., for instance, if a market falls more than 7 percent before 3:25 p.m. Eastern time, trading is halted for 15 minutes; a fall of 20 percent will halt trading for the rest of the day. Since implementation in 1987, the circuit breakers have only been triggered five times in the U.S.: once in 1997, and four times so far this month.
These circuit breakers give traders a chance to gather their wits and strategize rather than just try to catch the proverbial falling knife. They are seen as a breather that restores common sense and that might help panic sellers to see the error of their ways.
Keep them open
Fortunately, none of the arguments for full closure are as yet being seriously considered. The closure of the world’s principal trading venues would suspend price discovery, which is a fundamental mechanism of trade beyond stocks and bonds. And the blow to investor confidence in liquid markets from a prolonged shutdown would be severe and long-lasting.
But even more urgently, many investors will most likely need to sell shares or bonds for cash over the coming weeks to cover living expenses.
Also, market closures would not necessarily stop trading from happening – it would just move off-exchange to unregulated “back rooms” with no investor protection. As with nature, markets always find a way.
Even the concept of temporary circuit breakers is criticized as a market distortion. To mitigate the damage from technology glitches, fine, but why shouldn’t prices plummet in response to new information if they reflect investors’ opinions (however mistaken) on fair value?
What’s more, circuit breakers do have an ideological bias – notice there are no market-wide circuit breakers when markets move up, even though rapidly ascending indices can also encourage traders and investors to take foolish positions.
Business as usual
And then we have the crypto markets.
These never close. Ever. Crypto assets can be traded 24/7. Even if one exchange is down (which often happens), there is another one somewhere that can pick up the action.
Even if it were agreed that temporary closure is a good idea, there is no central authority to enforce that. Even if all the large exchanges agreed (work with me here), there would be many smaller exchanges happy to help traders express their market opinions. Heck, you don’t even need an exchange to sell your crypto assets – you and I could agree to trade via email if we wanted.
Investors in crypto assets, especially those who believe in the true purpose of markets, must take some comfort from the knowledge there is no way their intentions could be thwarted by a centralized decision.
Proposals have been made to introduce circuit breakers in crypto, arguing that the steep drop of over 15 percent in the space of 30 minutes on three different occasions on March 12-13 limits the usefulness of the technology. Some insist it is enough to scare many investors away. Others point out that were it not for an inadvertent circuit breaker in the form of a technical halt to trading on leading derivatives exchange BitMEX, allegedly due to a DDOS attack, the imbalance of bids vs. positions to liquidate on the platform could have pushed bitcoin’s price down to $0.
While the desire to protect the market is understandable, it flies against the very essence of crypto assets – they are decentralized stores of value that can be transferred from one party to another without going through a centralized authority.
An effective circuit breaker plan would require total centralization. First, who makes that decision? Consensus among all trading platforms? Not likely, especially as any holdout would reap rewards as trading flowed its way.
Second, when would the circuit breakers be triggered? Who decides that? Again, a consensus is unlikely, as is efficient implementation. Who would be responsible for making sure that all platforms complied? How would this be enforced?
The bigger question
This is a fascinating conversation for market nerds like me, as it gets to the root of what markets are for. Are they for allocating resources and messaging value? Or are they for protecting capital and preserving wealth? Are they there to crowdsource opinions as to economic outlook? Or are they there to boost investing confidence?
Much is uncertain about the environment and the outlook of the crisis we are going through. One thing is sure, though: we have not seen the last of wild swings. The temptation of many to use markets as a political tool in troubled times will run up against those that understand that markets are about more than making money.
Those working in crypto markets are well aware of this. They have no central authority to manipulate their platforms to influence investors – in that sense, the market is “free.” Yet, with freedom comes risk.
In the case of crypto markets, that risk has the form of disjointed oversight, sometimes lax security, relatively low investor assurances and occasional volatile swings with enough ferocity to make even crypto enthusiasts occasionally wonder if total centralization of rules isn’t such a bad idea after all. Mercifully, those bruised lapses in focus tend to be fleeting.
As with much about the current crisis, deep questions about what we want from crypto markets are being asked. Conversations are flowing, information is ample and meaningful answers are emerging.
Disclosure: The author is a long-term holder of a small amount of bitcoin and ether.
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