Assessing Bitcoin’s liquidity with Coinlib data is indefensible
In mid-January, a blogger writing under the moniker ‘Crypto Anonymous’ published an article in which they claimed that the price of Bitcoin was supported by unbacked Tether issuance. This analysis relied in part on data from a provider called CoinLib purportedly showing the flow of money within the crypto ecosystem. As I will demonstrate, this data is not sufficient to make the case that Bitcoin liquidity is dominated by Tether, and relying on it is liable to mislead. Unfortunately, the mainstream financial press is now amplifying these erroneous claims. (Note: this article is not a debunking of the ‘Bit Short’ article, which has already been done capably here, here, and here.)
Fake volume is a well-documented problem
When I read the ‘Bit Short’ article, I immediately knew that the author Crypto Anonymous was not, and had never been, a serious crypto market participant. If they were a real trader with meaningful capital at risk in crypto markets, they would have known that many of the exchanges composing the CoinLib sample are not credible, and that the resultant data was thus completely unreliable. My credentials on this topic? I am the cofounder of Coin Metrics, a data business that licenses crypto market data to financial institutions, asset managers, and banks. The CM team is well aware of this exchange data quality problem, and has developed a 36-point whitelisting framework which applies quantitative and qualitative tests to exchanges to determine whether they are providing honest data.
Naturally, many exchanges fail these tests. Quite frankly, there aren’t many exchanges or trading venues in the industry that meet the standards that public markets investors expect from a data quality perspective, although this is changing. Coin Metrics isn’t the only entity to point out that exchanges suffer from data quality issues, and that a robust whitelisting framework is required to obtain reliable volume assessments. Asset manager Bitwise famously determined in a report to the SEC that 95 percent of claimed crypto volume was fake, drawing a sharp distinction between credible, onshore exchanges (with fiat connectivity) and offshore exchanges (which often use Tether). Bitwise maintains an index of credible volume figures based on a whitelist framework. Alameda Research, one of the largest market makers in the industry, supported the Bitwise research with a report of their own on junk data, and administers their own fake exchange volume monitor.
Data provider Messari also takes the whitelist approach to derive “real volume” figures, pointing out in their methodology that “[it] is widely known that many exchanges conduct wash trading practices in order to inflate trading volume.”
Similarly, industry trade publication The Block manages an exchange whitelist of their own, which is more expansive than the one devised by Bitwise. Coin rankings site CryptoCompare equivalently publishes an exchange benchmark seeking to contextualize claimed volumes. In short, this problem is well-understood by anyone paying the slightest amount of attention to the industry. It beggars belief that a longtime crypto trader would not be aware of this fact.
And this information isn’t new. Industry leader CoinMarketCap’s struggle to derive reliable volume figures has been well documented in the mainstream press. I discussed the perverse incentives at play which cause rankings sites to uncritically accept faulty exchange volume back in 2018. In short: start-up exchanges fake data so they look liquid and active, both to encourage tokens to pay listing fees, and in an effort to get traders on the platform. Rankings sites often have financial relationships with the exchanges they cover and have little incentive to denoise the data.
The problem is endemic to crypto markets. Anyone paying the slightest amount of attention to the industry would have known that the Tether-based exchanges were prone to overstating volume. This naturally skews assessments of market liquidity and consequently has the effect of overstating Tether’s influence on the market. Remember, it’s the offshore, generally non-fiat connected exchanges that tend to fabricate volume, so uncritical aggregates will end up overstating Tether’s role in Bitcoin price formation.
Now why is this a problem? Because CoinLib is taking the data outputs from marginal exchanges as face value, and unsophisticated analysts like CryptoAnon are using it to disseminate a narrative about Bitcoin’s liquidity.
If you consider the seven most liquid exchanges according to CoinLib, only Binance, Coinbase Pro, and Bitfinex would pass muster with most of the whitelisting frameworks listed above. In the Coin Metrics trusted volume framework, Lbank, ZB, and HitBTC — three of the largest exchanges in the CoinLib sample — do not pass the filter. They are not considered credible. Data provider Nomics, which filters exchanges for credibility, gives Lbank, ZB.com, and Bit-Z a C, and HitBTC and A-. Cryptocompare gives ZB.com, Lbank, and Bit-Z a C, and HitBTC a B. Messari and Bitwise only include data from Binance, Coinbase, and Bitfinex in the top 10 exchanges cited by CoinLib. The Block’s index of 24 legitimate exchanges only considers 4 of the top 10 presented by CoinLib to be credible. We’re talking about billions upon billions of fictitious USDT volume.
So if you actually dig into the CoinLib data, the crucial error becomes starkly clear. Each of Lbank, ZB, BitZ, and HitBTC are USDT-only exchanges. And each of them gets consistently poor grades from the data aggregators or is excluded from the whitelists. But CoinLib takes a naive view, uncritically accepting their claimed volume figures as fact.
A fact-checking failure by the WSJ
Now, anonymous posters on Medium are one thing. For all we know, Crypto Anon could have a massive short position and could be talking their book. We have absolutely no reason to trust them: caveat emptor. But when those claims get rebroadcasted and treated as factive by mainstream financial publications, we cross into the domain of journalistic malpractice.
Unfortunately, that’s what happened today. Andy Kessler, Wall Street Journal columnist, wrote a piece entitled ‘Behind the Bitcoin Bubble’ [archive link]. In the piece, he repeated the claims made by CryptoAnon, effectively endorsing them. In support of his argument that “Bitcoin is nothing, it’s vapor, a concept of an idea” Kessler wrote:
[A] poster named Crypto Anonymous (for what it’s worth, know your customer) did some digging and found that as much as two-thirds of bitcoin buys on any given day were purchased with tether […]
Now normally, if you are a columnist writing in one of the most respected financial publications, you might try and evaluate the data behind that claim, instead of just uncritically accepting it. But Mr. Kessler did no such thing. He just blindly repeated a fanciful claim from an anonymous blogger in order to imply that Bitcoin’s price was somehow dependent on Tether.
Kessler’s misunderstandings are numerous. First of all, the CoinLib data is simply not indicative of Bitcoin’s liquidity profile. Bitcoin has extremely deep direct fiat liquidity. The asset is not dependent on Tether to trade. Virtually none of the U.S. based exchanges — where the plurality of the world’s crypto trading occurs — employ Tether. These exchanges are directly connected to banks like Silvergate, Metropolitan, and Signature. Exchanges Gemini and Coinbase even boast on JP Morgan as a service provider. A number of highly-regulated entities like the CME, ErisX, and the Intercontinental Exchange (via Bakkt) host the trading of Bitcoin derivatives under the watchful eye of the CFTC. Other entities like Cash App, Paxos, Paypal, BlockFi, Robinhood, Bitwise and Grayscale all facilitate various forms of exposure to Bitcoin and are connected to the commercial bank system and in some cases publicly-traded companies. No Tether present. And lastly you have crypto firms like Avanti, Kraken Financial, and Anchorage which boast shiny new bank charters (whether through states like Wyoming or at the national level). Suffice to say, in the U.S., crypto markets are tightly integrated with the commercial bank system and have no dependency whatsoever on Tether.
Stablecoins, while an increasingly vibrant financial infrastructure, are not necessary to support the trading of Bitcoin in the U.S. Today, Bitcoin has robust, surveilled, and capacious USD liquidity. Tether could evaporate overnight and change absolutely nothing about the Bitcoin markets in the U.S.
The second mistake Kessler makes is in confusing volume with flow. Volume simply means trading in an asset. The CoinLib charts purport to demonstrate the “Money flow from/to Bitcoin” but they do nothing of the sort. Rather, they show an (extremely noisy) compression of where volumes are occuring.
But CoinLib, and by extension Crypto Anon and his unwitting acolyte Kessler, conflates exchange volume with actual inflows. Leaving aside the junk data element for a second, exchange volume is heterogeneous. A retail brokerage transaction bearing a 200-bp fee at Coinbase is much likelier to represent an inflow of capital than a leveraged BTC-USDT futures trade on FTX, Binance, or Huobi. Real inflows are hard to directly measure, but some proxies are available. Grayscale BTC acquisitions are indicative of actual inflows into the asset. ItBit data is considered by some to be a proxy for Paypal BTC purchases. Square publishes client BTC purchases in their quarterly reports. It’s a matter of fact that the publicly-traded company Microstrategy acquired 70.8k BTC. Coinbase will shortly publish an S1, giving investors an even better idea of the relationship between their volume and inflows. And we keep hearing about multi-hundred million dollar buys facilitated by NYDIG, Coinbase Prime, and my former colleagues at Fidelity Digital Assets. The point is, there is a provably large onshore BTC/USD market, and its scope can be ascertained through a patchwork of public sources, if you care to look. Additionally, exchange volumes must be contextualized, as exchanges vary dramatically in the sophistication of the client base and fee structures.
Tether is undeniably important within crypto markets. It’s the main (but not sole) currency that traders use to settle and hold a balance on exchanges, especially those without connectivity to the U.S. banking system. It denominates derivative contracts on many offshore crypto exchanges. But it is simply erroneous to treat Bitcoin liquidity as homogenous, and moreover to claim that liquidity constitutes inflows. Grayscale’s Bitcoin purchases (with real US dollars) constitute inflows. Offshore USDT-denominated crypto exchanges fabricating orderbooks and creating wash trades so they appear liquid couldn’t be more irrelevant to price formation. It’s just noise.
Mr. Kessler had the time to contact the NYAG and ask about the status of their investigation into iFinex Inc. But he didn’t bother vetting the extravagant claims made by anonymous bloggers relying on junk data. He could have spent five minutes and called any crypto trader or market participant and asked them if CoinLib was a reliable source, or if ZB.com was a credible exchange. But he didn’t, because he wanted to believe a contrived narrative and the data presented by the anonymous blogger fit that narrative. (If you want to know what is really driving this rally, read my recent explainer on the topic.)
Look, I get it. Crypto data can be confusing. But to comment on crypto issues, in particular extremely complex ones like the liquidity profile of Bitcoin and other globally-traded cryptoassets, you cannot rely on surface-level data analysis. If you take assumptions from traditional markets and transpose them, you will go wrong.
Now if the WSJ is willing to uphold their editorial standards, they will retract the erroneous claim and issue a correction. A shadow edit, the all-too-popular method that the press uses to slyly cover up its blunders, won’t suffice (I’ll be watching). The Tether story may well have legs, but skeptics do themselves a disservice by enlisting the help of unsophisticated, anonymous bloggers and by relying on easily-debunked data. Tether is a story worth covering. The case of the world’s largest stablecoin is, indeed, an interesting story. But wild theories relying on data that everyone in the crypto industry knows to be erroneous do no one any good.