Price discovery is a fundamental part of every secondary market, including cryptocurrency. Price discovery helps to give an accurate value of an asset based on market activity.
As a Bitcoin holder and trader, you rely on price discovery for buying and selling decisions.
You rely on it for measuring your performance, determining taxes, and making accurate payments. And through your trading activities, you also contribute to the price discovery process.
Price discovery helps shape the entire altcoin and token market where ETH and BTC are used for purchases and funding.
The growth in various other crypto products and services are also contributors. All of these elements enhance the accuracy of the maturing crypto price discovery mechanism.
Part of this discovery is also driven by institutional involvement.
MicroStrategy helps price discovery in Bitcoin
One significant influence is Microstrategy. Since their first BTC acquisition announcement in 2020, they have grown their stake to more than 114,042 BTC. They have been buyers in every decline, helping to shape short-term pricing expectations. Their ongoing and growing stake is also a reflection of future expectations for BTC.
Their lead has helped shape pricing by giving the green light to numerous other institutions to get involved. Participation by a growing number of large institutions all contributes to more accurate price discovery. Over time, participants in a market shape the price as they add and remove positions in different assets.
Up until recently, Bitcoin was described strictly on a relative to dollars basis. Today the Bitcoin price is a reflection of an increasingly intricate series of pricing signals.
New crypto products and services help provide more accurate information about prices for the crypto assets they support. These products include derivatives, DeFi, fund flows, and stablecoins, amongst others.
Price signals from options and futures
The Bitcoin or Ether price you see on the Bitvo Exchange, or any other Canadian crypto exchange, represents the price for BTC and ETH trading worldwide. It also represents an interplay between derivatives like futures and options.
Sophisticated traders use futures and options to add exposure to cryptocurrencies and other assets. They also use them to hedge exposure. The futures and options contracts they buy at different strikes and contract dates send pricing signals across the market.
The pricing reflects in part the hedgers and speculators in assets with futures and options exposure.
Options and futures have also led to the use and expansion of leveraged trading. The addition of leveraged trading exacerbated volatility across crypto. This has occurred primarily through leverage in Bitcoin. However, several leverage liquidations in 2021 has resulted in leverage being reduced by providers like FTX.
Signals from Bitcoin options and futures find their way into your inbox. It is not uncommon to hear how options volume is bullish or bearish for BTC based on the put/call ratio. The press extrapolates trading expectations from futures volumes, contract dates, and prices.
These reports influence readers trading the spot or cash markets on exchanges.
Futures have even permeated the ETF space with the addition of the Proshares Bitcoin ETF.
Bitcoin ETFs BITO, BTF and XBTF
In 2021, Proshares received approval for their managed Bitcoin futures ETF, BITO.
The much celebrated approval represents another mainstream financial product designed to serve the growing demand for crypto market exposure.
The product uses cash-settled Bitcoin futures contracts on the CME. The fund does not own BTC directly. A portion of the fund is also simultaneously invested in US treasuries. This product caters to sophisticated investors looking for different kinds of exposure.
Proshares wasn’t the only ETF to come out.
The Valkerie Bitcoin Strategy ETF (NASDAQ: BTF) followed shortly after. Then came the VanEck Bitcoin Strategy ETF (BATS: XBTF). These aren’t the first Bitcoin ETFs on the market. That title belongs to Canada’s 3iQ.
The approval of several ETFs in the US further enhances the price discovery mechanism in Bitcoin. Ethereum looks like it will be next.
Price discovery is also shaped by arbitrage across international markets. And that’s where stablecoins come in.
Stablecoins arbitrage out BTC price differences
Stablecoins have played an important role in crypto price discovery as well. During the ICO boom of 2017, Dan Matuszewski described how large traders used Tether to quickly arbitrage from the US to China. The market was still relatively young and unsophisticated during that period, which meant large price disparities between different markets. And big opportunities.
It was the use of stablecoins that helped reduce BTC price disparities around the globe.
Stablecoins provide faster access around the cryptosphere, making arbitrage more efficient. This arbitrage helps to improve pricing efficiency in the leading cryptocurrencies like BTC, ETH, XRP, and others around the world.
Stablecoins are among the fastest-growing areas in crypto. USDC, the number two stablecoin by assets, has grown to more than $30B US in reserves as of 2021.
DeFi the speculative version of price discovery
On Ethereum, the platform is shaping crypto through smart contract-based protocols. The explosion of stablecoins has increased traffic and fees on the platform. And the rapid expansion of DeFi and NFTs has also added significant demand, shaping pricing.
DeFi represents a significant experiment with constant evolution. Numerous projects explore value discovery through staking, lending and yield farming. ETH and BTC are used to buy altcoins that are staked to earn yields from automated market makers like Uniswap (UNI).
As a result, DeFi has become part of the leading cryptocurrency price discovery mechanism.
And price discovery can occur through blowups and controversy. Various projects in the DeFi space, like the infamous Yam, going to $150 one day and zero the next, demonstrates the risks inherent in DeFi. Or the notorious SushiSwap saga where prices were dependent on a variety of unknowns, including the integrity of the anonymous founder.
These experiments and subsequent failures help to shape pricing behaviour in the riskiest part of this market. As the old expression goes, once bitten twice shy.
The influence of fund flows
Funds are another source of price signalling. Fund flows indicate the expectations of some participants in the space. Greyscale’s fund family is a great example of a fund providing price signalling in cryptocurrency contributing to price discovery.
Demand for these funds, or movement out of them, can influence demand and supply of the coins they trade.
Other funds, like hedge funds, help add another pricing dimension. The originals like Galaxy Digital, Pantera, and Travis Kling’s Ikigai are joined by many other investment and trading funds. The expansion of the number of funds and their activity becomes a valuable element of the price discovery in markets like cryptocurrencies.
NFT marketplaces like OpenSea and NBA Top Shots show us the evolution of demand and pricing. They also show us how pricing can be both a perception and influenced by other things.
When art is priced in dollars, the perception appears to be different than when it’s priced in ETH.
Consensus and crypto miners help shape prices
Crypto miners are one of the original elements in the price discovery process. Mining rewards and the minting of new coins provide a constant but dwindling supply for Bitcoin. Changing the mining rewards like the 2020 Bitcoin halving shapes price discovery around the protocol.
A variety of consensus interpretations create different influences on rewards and subsequent pricing. Ethereum’s switch to proof-of-stake is a good example of redefining price discovery through the consensus mechanism.
It is the ongoing securing of the network without human intervention that adds confidence in the system. Confidence, created through crypto consensus and governance structures, is an important factor in price discovery.
The dynamism of crypto price discovery
Prices are dynamic feedback loops involving an array of financial products and signals, including the influence of leverage.
Accurate pricing helps with risk transfer from users to speculators. It helps with insurance pricing and more accurate determination of yields. A mature price discovery mechanism means you can use exchanges that maintain pricing around the international best bid and offer.
Traditional markets have interest rates, government debt, risk-free rates, equities, derivatives, swaps, and numerous other elements that contribute to price transparency.
Cryptocurrency is quickly developing a similar structure that provides a nervous system for pricing. Accurate real-time pricing internationally is an important element of crypto. It gives a clear signal of the real-time value of crypto assets like Bitcoin, Ether, and others.
This, in turn, helps people make better, more accurate purchasing decisions. Better pricing helps drive wider adoption of crypto as a value storage and payment medium.
And mature price discovery means you can buy, sell and trade Bitcoin, Ether, ADA (Cardano) XRP, Litecoin, Dash, and others with confidence.
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