As the bones of the economic structures that our societies rely on have been laid bare, the fragility of the global economic ecosystem has been revealed. This is particularly true for novel markets that don’t have ‘circuit breakers’ and other protections in place that many traditional markets do: in particular, cryptocurrency.
Indeed, perhaps more than in most traditional markets--or at least, in unique ways--the economic fallout from the coronavirus has dealt a number of blows to crypto: at times, prices cliff-dived; the trading frenzy that ensued revealed vulnerabilities in the trading infrastructure that crypto holders rely on.
Of course, the economic havoc that the coronavirus wreaked was certainly not unique to crypto: when financial markets began to react to the coronavirus, cryptocurrency prices were (at times) less volatile than, for example, oil prices.
Still, the chaos that the coronavirus has wrought on crypto has ignited an important debate in the cryptocurrency sphere: should crypto markets have circuit breakers or other, similar protections in place? And indeed, is their eventual presence on cryptocurrency exchanges an inevitability?
In a way, circuit breakers violate the guiding principles of the crypto community
In a way, the very concept of protections like circuit breakers goes against the written or unwritten law of the cryptocurrency ethos--many cryptocurrency traders and community members are ardent advocates of a truly “free” crypto market.
Pankaj Balani, chief executive of cryptocurrency derivatives Trading Platform Delta Exchange, told Finance Magnates that indeed, “having a blanket protection such as a circuit breaker is at odds with the core belief of a free market and that of a demand-supply driven price discovery--ideas that are quite popular in the crypto community.”
Pankaj Balani, chief executive of cryptocurrency derivatives trading platform Delta Exchange
Additionally, Jose Llisterri, co-founder of cryptocurrency derivatives exchange Interdax, echoed Balani’s sentiments--he told Finance Magnates that in his view, “there should not be protections in place, so crypto can continue to operate as a truly free market, purely driven by supply and demand.”
“Putting circuit breakers in place violates this principle, as there’s always one side of a particular trade that is adversely affected by a pause in trading,” he explained.
However, not bringing circuit breakers into the cryptocurrency trading space could allow a different kind of price distortion to take place--with less control, and potentially higher consequences.
“Because of the nascent stage of the industry, and as evidenced during the March crash, the liquidation engines of the most popular derivatives trading venues are oftentimes cannot handle the [trading] load,” Llisterri explained.
This “ends up distorting the market.”
If circuit breakers aren’t implemented, infrastructural failures may distort prices anyway
This phenomena was also explained by Miko Matsumura, co-founder of the Evercoin cryptocurrency exchange and general partner at Gumi Cryptos Capital, in an interview last month.
Specifically, Miko referenced the infrastructural failures that may have temporarily locked in traders’ funds on cryptocurrency exchange BitMEX on March 12th, 2020, also known as “Black Thursday.”
“BitMEX as an example–”what we saw was $700 million in leveraged margin trading essentially getting liquidated–so they got kind of ‘blown up’” he told Finance Magnates. This sudden and large-scale liquidation “create[d] a local pricing phenomenon.”
Miko Matsumura, co-founder of the Evercoin cryptocurrency exchange and general partner at Gumi Cryptos Capital.
“There [was] so much leverage on margin trading that when people’s stacks get liquidated, it creates a locally lower point for the Bitcoin price than the global price. But the problem is that if your assets are stuck in that bubble, you’re unable to access the global price…that creates more potential for panic-selling and those kinds of things.”
Kyle Samani, co-founder and managing partner at Multicoin Capital, also explained this particular phenomenon in a report that was issued in mid-March on the corona-related crisis.
“During times of crisis, [exchanges] become so congested that arbitrageurs cannot keep prices in line across venues, causing massive dislocations on individual exchanges,” he wrote.
In the case of BitMEX, “massive dislocations on a single exchange caused Bitcoin to dip below $4,000 for 15-30 minutes; however, this would not have happened if the market operated correctly.”
Finding a protective middle-ground
Therefore, it may well be that crypto exchanges and traders are damned if they do, and damned if they don’t; in other words, circuit breakers may not be an ideal fix for preventing chaos on crypto markets, but until cryptocurrency exchange infrastructure can be designed to support large-scale liquidations without price distortion, circuit breakers may be the best solution.
Jose Llisterri said that for this reason, some may find it “sensible to seek a middle-ground and add a minimal set of breakers that ensure an orderly market at all times while preserving the ideological aspects as much as reasonably possible.”
And in fact, the practice of implementing protections such as or similar to circuit breakers already seems to have increased in the time since the mid-March coronavirus chaos--though they aren’t quite as easily-triggered as those in traditional financial markets.
Interdax co-founder and Chief Product Officer Jose Llisterri.
“After the Covid market rout, some crypto derivatives exchanges have introduced measures similar to circuit breakers, although these work differently than the traditional markets counterparts,” Llisterri explained. For example, “on traditional venues such as NYSE, trading is completely halted after specific percentage price deviations (7%, 13%, 20%).”
For example, on March 9th, 2020, and again on March 16th, circuit breakers were triggered at the NYSE as the DJIA fell more than 7% at the open.
However, Llisterri explained that “instead, crypto exchanges, such as FTX, Huobi or Interdax, resort to more suitable solutions without causing disruption to the market,” Llisterri explained.
“These solutions range from; unwinding gracefully the positions of traders operating on high leverage, locking the price movements around trading bands which prevent exacerbated flash crashes/spikes, to improving the calculations of their indices with formulas robust to outliers.”
Circuit breakers will only truly be effective if they are adopted by all crypto trading venues
But are these kinds of protections sufficiently effective?
Pankaj Balani said that the unique qualities of the cryptocurrency trading ecosystem--specifically, the “fragmented nature of the industry and that of Liquidity in the crypto markets”--provide a set of challenges that make designing protections difficult.
In other words, there are a huge number of crypto exchanges, many of them unregulated--as such, traders who weren’t happy with an environment equipped with circuit breakers could easily move their business onto another exchange.
Indeed, “having an effective circuit breaker is difficult to implement given the current state of the crypto ecosystem,” Balani said. “To have an effective circuit breaker, one that can absorb market shocks, a consensus on price limits, time limits, and other mechanics is needed between various spot and derivatives exchanges.”
Michael Creadon, a board advisor at Inveniam Capital Advisors, shared a similar point with CoinTelegraph: “circuit breakers won’t work because there are too many exchanges and no centralized rule-making body” he said.
“If Coinbase freezes up but the market moves another 50% on Binance, you won't be able to get out. So you’re damned if you do, damned if you don’t. For long term hodlers, I think this is less important. For day traders, this is very important. Circuit breakers are a good thing, but hard to deploy when there are hundreds, if not thousands, of trading venues.”
