Bitcoin musings

I incidentally had a wander around the Bitcoin ecosystem in the past few days and there are a number of entertaining phenomenons to observe.

MtGox: a slow train crash

Looking at comparative exchange rates between Bitcoins and fiat currencies, one can’t help notice that BTC are 10% more expensive at MtGox, the highest volume Bitcoin exchange, than at every other exchange. The reason is not hard to find: MtGox has problems with their banking partners so that they have limited capacity to process withdrawals, and have thus set up a rate-limiting (both time and size) queue system. So basically it takes weeks to get money out of MtGox, making the obvious arbitrage opportunity of buying cheap bitcoin from any other exchange and getting back your original capital + 10% by selling it on MtGox and withdrawing it much harder (or for people who are BTC-based, the mirror strategy of buying fiat temporarily and converting it back into Bitcoin via cheaper exchanges). Of course the arbitrage is less interesting when (1) it takes weeks, (2) is limited in size, (3) MtGox might not be there by the time your withdrawal is due.

Interestingly MtGox remains the highest volume exchange despite being functionally insolvent — any old school bank sitting on funds for a month would be put in resolution by their regulator and counterparties would run away from it as fast as possible. It would be interesting to know how much of the remaining volume is the arbitrage trade and how much is people actually needing a transfer for non speculative reasons. Some inertia might be due to the difficulty of being validated on other exchanges.

Bitcoin exchanges: a flawed idea

MtGox problems are I think revealing a more fundamental problem. The entire modern banking system is oriented towards traceability and, to a degree, reversibility. Interestingly MtGox’s euro bank sits on incoming electronic transfers for 7-10 days, presumably to cope with reversals. Any transaction chain that gets out of regular banking and back in again via Bitcoin is in principle a loophole in the world banking system (let’s assume for a moment that Bitcoin is as anonymous as its proponents claim).

The way it seems to work is that while a new Bitcoin exchange is small enough to be under the radar it’s left alone until it becomes big enough to trigger compliance problems and then loses its interface with the regular regulated money world. I don’t think that’s going to get any better, limiting the potential for Bitcoin to gain wide acceptance. It can still work as an underground currency by using bridge goods for exchange, or peer-to-peer exchange, like LocalBitcoins, which basically works around the regulations by turning private individuals into unlicensed money changers, probably breaking some rule or other but possibly escaping it as long as individual members operate on an amateur scale.

ICBIT futures contango

Another arbitrageable anomaly is the contango curve for BTC/USD futures on the ICBIT futures exchange. Liquid things normally have a flat term structure, because you can construct a market neutral position with the underlying and the future and gain the difference in a risk free manner.

Some possible explanation for this contango:

  • innumeracy may dominate, if more people believe that the future prices for liquid assets are bets about prices at expiration than there are people prepared to arbitrage this basic error.
  • the icbit exchange is too small to be worth bothering (the open interest on the BTC/USD futures is less than $400k nominal).
  • an arbitrage position that is short is subject to infinite risk if the price on icbit spikes before converging at maturity.
  • an arbitrage position is exposed to counterparty risk: the exchange, like many bitcoin ventures, is probably a one-man shop who can at any time disappear with the margin account or get it hacked/stolen.

Fees: even more expensive than regular finance

One striking thing is that bitcoin exchanges, and other bitcoin-based financial websites, despite skipping the full regulation of the regulated world, charge fees that are can be higher than the regular regulated financial industry, for example an arbitrage transaction getting euros in via Bitstamp and out via MtGox would cost:

  • Bitstamp deposit: unspecified USD/EUR cost
  • Bitstamp exchange fee: 20-50 bps (volume dependent)
  • MtGox exchange fee: 25-60 bps (volume dependent)
  • MtGox withdrawal fee: 100 bps

A speculative forex round trip with a competitive regulated money solution is much cheaper than that.

These services are just a bit of software, with a supporting geek community, it’s surprising cooperative services that don’t charge fees haven’t appeared.

Another look at fees is the cost per transaction shown on blockchain.info which seems to oscillate around 2-3% which seems pretty steep to me for transactions within a purely electronic currency with no services attached. I understand this includes the block fee from BTC created and given to miners, which are not paid directly as part of the transactions, but are fair to include given that they increase market cap and thus, everything else being equal, devalue existing bitcoins.

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