High-Speed Trading for Bitcoin Just Hit a Speed Bump

By Patrick Tan on Altcoin Magazine

Patrick Tan
May 24, 2019 · 6 min read

Coinbase, one of the U.S.’s largest Bitcoin exchanges has abandoned efforts to lure High-Frequency traders to its exchange.

Tyler Cunningham knows the streets of San Francisco like the back of his hand. He is particularly familiar with Post Street, where the Apple store sits at Union Square — the veritable mecca of Apple’s products and a temple for its legions of cult followers.

The reason that Cunningham has such intimate knowledge of the location is because every so often, when Apple releases the latest iPhone or a new tech product, he’ll be in line, waiting to snap it up for resale later to the devout fans of the technology company, willing to pay a hefty premium to be first among equals.

Cunningham, a computer arts graduate from San Francisco University and who works at a local animation firm, does it just for kicks, but he says that the profit margins are unbelievable.

As long as you can get ahead in line and place your order first, you’re almost guaranteed a profit.

First in Line Makes the Dime

Which is the exact same principle behind High Frequency Trading or HFT.

The idea is that even a nanosecond’s advantage in placing your trade order ahead of the rest of the market can yield profit, is what powers HFT outfits occupying some of the priciest real estate around Wall Street and the premise behind the movie The Hummingbird Project.

But while HFT may have taken off in the financial markets, accounting by some estimates for almost half of the daily volume in U.S. stock trading — they are also viewed suspiciously by more traditional investors, who fear that HFT firms eat into their profits by zipping in and out of stocks, while slower-moving players execute trades (gasp) manually.

By one measure, HFT firms create a competitive advantage that regular investors could never hope to emulate, alienating a segment of the investing population and raising barriers to entry in what ought to be a fair, open and accessible marketplace for an opportunity.

By another measure, considering the amount of trading volume that HFT firms generate, they are a crucial piece in the market puzzle, providing order book depth and the liquidity which is essential for a well functioning and efficient marketplace — essential ingredients for a market operator’s survival.

Sauce for the Goose is Sauce for the Gander

Which is why last year, Coinbase, one of the largest cryptocurrency exchanges in the United States unveiled substantial efforts to draw in HFT cryptocurrency traders by carrying out tech upgrades, including speeding up its matching engine — the system that match-makes “buy” and “sell” orders efficiently.

Presumably, greater HFT activity at San Francisco-based Coinbase would have boosted trading volumes and revenues and perhaps provided a gateway for institutional investors to enter the cryptocurrency markets.

And given the moribund cryptocurrency markets in 2018, it’s understandable why Coinbase would be searching to boost revenues.

The embattled firm, which had over 600 employees as late as December 2018 has already had to lay off 30 people from its Chicago office — but layoffs have not been peculiar to Coinbase alone as even firms like Ethereum co-founder Joseph Lubin’s Consensys have had to contend with prolonged sluggishness in cryptocurrency prices and let staff go.

Across the cryptosphere, firms are tightening budgets and cutting on staff, in what are likely growing pains in the nascent sector.

To be sure, cryptocurrency prices have risen somewhat from their lows at the earlier part of this year, but are far from the highs, the yacht parties and the supercars that characterized late 2017 and early 2018.

Yet cryptocurrency exchanges seeking to boost earnings by attracting HFT firms may be barking up the wrong tree.

Not Sauce for the Gander

For starters, cryptocurrency exchanges are already plagued with the rather dubious honor of having as much as 95% of their trading volumes faked — through the use of automated algorithmic trading bots — the very tools of HFT firms.

Then there are allegations of rampant market manipulation by both traders as well as cryptocurrency exchanges — leaving many retail investors flat-footed.

On decentralized cryptocurrency exchanges, where bidding up transaction fees can afford a trader priority in executing transfers, cryptocurrency traders have been using bots to front run trades — the practice of jumping the line ahead of other traders (while being able to observe those orders) to profit from executing a trade first.

Against this backdrop, Coinbase’s attempt to lure HFT firms into the fray was bound to be challenging at best, considering that similar practices already exist in cryptocurrency markets.

From an institutional HFT perspective — there is little incentive to participate in cryptocurrency markets when many activities such as front running and market manipulation are rife and which put pressure on HFT firms to generate any meaningful advantage through HFT strategies.

To be sure, cryptocurrency trading (whether fiat-crypto or crypto-crypto) has always started off as a grassroots-led initiative. The world’s first and most infamous Bitcoin exchange was Mt. Gox, where early adopters of Bitcoin could buy or sell the first cryptocurrency.

The ethos upon which Bitcoin was created was a decentralization of power and finance — the very antithesis of institutionalization of investment and centralization of influence.

For many involved in cryptocurrencies, introducing HFT would be a retrograde step in the development of a decentralized world and counter to the philosophy of the Bitcoin whitepaper.

Which is why it comes as no surprise that the 30 people laid off by Coinbase in its Chicago office had all been working to improve the company’s technology to cater to speedy traders.

While Coinbase may have upped the speed of its matching engine by a factor of 20 compared with late 2017, its abandonment of its HFT initiative should be welcome.

If cryptocurrencies are to genuinely reach wider adoption and consideration, moves to facilitate trading and transactions should be inclusive and marketplaces should attempt to be egalitarian — HFT is not one of those moves.

Just as the initial coin offering (ICO) bubble was built on the philosophy of providing access to startups and pre-ICO profits to the average retail investor (regardless of how this ultimately played out), cryptocurrency exchanges ought to provide egalitarian platforms that level the playing field so that even the least sophisticated cryptocurrency trader has a fair shot at making a profit — if it is to truly provide a value proposition and meaningful alternative to the current financial system.

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Patrick Tan

Written by

CEO of Novum Alpha, an all-weather digital asset trading firm that uses Deep Learning tools to deliver dollar-returns in all market conditions.

The Capital

A publishing platform for professionals in business, finance, and tech

Patrick Tan

Written by

CEO of Novum Alpha, an all-weather digital asset trading firm that uses Deep Learning tools to deliver dollar-returns in all market conditions.

The Capital

A publishing platform for professionals in business, finance, and tech

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