- If the fragmentation of the global bitcoin market is not addressed, it could delay the market’s maturity
- If crypto markets were regulated like commodities markets, there would likely be capital reserve requirements preventing lenders like Celsius from over-leveraging customer deposits
As of July 2022, there are 498 crypto exchanges. No two exchanges have exactly the same price quote for Bitcoin at any given time.
This creates problems for institutional investors, Bitcoin’s liquidity and fungibility, and its future.
To get an insight into Bitcoin market fragmentation, what it means and possible solutions, we spoke to the team at Apifiny.
Bitcoin market fragmentation
In traditional markets, trading in assets takes place within a regulated framework established by some form of financial authority. In crypto markets, exchanges use bids and asks on an order book to determine their own price.
Because these exchanges lack a central regulatory authority, a hierarchy of pricing authority is absent. There is no single metric that anyone can point to and say, “This is the current price of Bitcoin.” The next alternative is an aggregate price indicator that averages the prices of some exchanges.
We spoke to Haohan Xu, Founder and CEO of Apifiny, to learn more about Bitcoin market fragmentation.
Haohan started out by defining fragmentation as “the disconnected and dispersed marketplaces in crypto.” He went on to say that crypto exchanges are regional and tend to “dominate their respective markets with their respective fiat currencies.” In such markets, prices tend to adjust to their regional supply and demand, or as Haohan put it, “…This creates many isolated pools of liquidity for Bitcoin. Each exchange is essentially its own marketplace and participants in each marketplace only trade among themselves and have a very difficult time leveraging liquidity from another exchange.”
This type of market structure prevents many institutional investors and professional traders from getting the best price and desired liquidity from Bitcoin and other cryptocurrencies at all times. One solution is to use Smart Order Routing to find the best price. Apifiny is including this tool in one of its service offerings, Apifiny Connect, but is working on comprehensive solutions for fragmentation.
The state of bitcoin fungibility
Fiat currencies are fungible. The value of a dollar is the same in California, New York and around the world.
The fragmentation of the bitcoin market, on the other hand, makes it less fungible. The price varies from exchange to exchange. And since the number of exchanges around the world is changing rapidly, the price of bitcoin also varies from region to region. This lack of fungibility can create problems for those working with large amounts of capital, as Haohan described:
“If you are trying to buy a large order of bitcoin at once, say 10 bitcoin. A single exchange does not have enough liquidity to execute this trade with minimal price drop. So you want to try and run this across multiple exchanges at the same time, but a few years ago there just wasn’t the infrastructure to do that.”
liquidity challenges
In 2022, a crypto liquidity crisis caused cascading consequences across markets. The current bear market, or “crypto winter,” has been marked by many exchanges and lending/credit platforms suspending withdrawals and filing for bankruptcy.
Crypto companies like Celsius Network, Three Arrows Capital, Voyager Digital, CoinFLEX, BlockFi, Bancor, Babel Finance, and Vauld have all been impacted in one way or another. As a result, they were forced to liquidate whatever assets they could to pay off debts. Fragmented markets amplify these types of selling pressures as they make it difficult to move liquidity to where it is needed most.
For example, massive selling pressure from a liquidation event can lead to a dramatic price slide on illiquid exchanges – meaning the large market order is driving down the price at which it is being sold. As a result, a single trade can result in a large price imbalance between exchanges. Arbitrage traders may be able to fill the gap, but this tends to exaggerate losses as it fuels more fear and continues the liquidity crunch.
If crypto markets were regulated like commodities markets, there would likely be capital reserve requirements preventing lenders like Celsius from over-leveraging customer deposits. However, this would not solve the price fragmentation problem. Bitcoin price discrepancies are a persistent reality regardless of liquidity crises.
In 2021, Taylor and Francis Online published a report by Jakob Albers that highlighted the ongoing fragmentation of the Bitcoin market. Order book data they collected from a sample of exchanges showed that exchanges with higher volume and liquidity consistently lead the smaller exchanges in price action. This shows that price fragmentation is a consequence of liquidity fragmentation.
The Future of Bitcoin
If global bitcoin market fragmentation is not addressed, it could delay market maturity. As assets develop, they typically become more liquid and more regulated, which helps reduce volatility. According to Haohan, continued fragmentation could cause Bitcoin to remain volatile for now:
“All smaller exchanges lose a lot of bids and asks being thrown around when liquidity is low and prices can change wildly during volatile times. So unless the fragmentation issue is addressed over the years, Bitcoin will continue to be a highly volatile asset.”
How can this be addressed? The answer could be a mix of regulation and innovation. The two are dependent on each other to a certain extent. As Haohan put it, “Regulation can’t solve any of this without the right tools, and obviously innovators are the ones providing the tools. But innovation needs regulation, and so regulators might say, “I want to regulate crypto a certain way,” but if the tools to do it just don’t exist, there’s not much they can do.”
It all boils down to counteracting liquidity fragmentation by merging the settlement systems of different exchanges. Haohan explains, “The fragmentation actually exists in the clearing-settlement layer, not the market layer. So let’s say you unify the wallet systems or the clearing settlement systems of Coinbase or Gemini, then this trader can use his funds to trade on both Coinbase and Gemini and there wouldn’t be such a big problem with price difference, because they’re all in the same ecosystem.”
We asked Haohan what Apifiny is doing to solve these problems. He replied: “We are focused on building the infrastructure for professional traders or institutions to allow full access to the market in the most seamless way possible. So, our end goal here is to use strong infrastructure as a method to consolidate and glue together a full crypto market for traders to have one-stop access to pricing and liquidity; cross trading site fund rebalancing and management; to post-trade reporting and analysis.”
Apifiny has been working hard to address one of the biggest challenges facing the crypto market. It requires a fine synergy between innovation and regulation. But once the two find a clear and pervasive fix, they have the potential to spark a massive adoption wave. Resolving market fragmentation will lead to price stability and real benefits. Businesses will be more willing to use it for their businesses, financial advisors will be more inclined to recommend digital assets to clients, and consumers will be drawn to its ease of use and store of value.
This content is sponsored by Apifiny.
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Brian Nibley
Brian is a freelance writer who has been involved in the cryptocurrency space since 2017. His work has appeared in publications such as MSN Money, Blockchain.News, Robinhood Learn, SoFi Learn, Dash.org, and others. Brian also contributes to Nicoya Research’s investment newsletters, analyzing tech stocks, cannabis stocks and crypto.
Learn Crypto Trading, Yield Farms, Income strategies and more at CrytoAnswers
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