Price discovery in Bitcoin, Ether and crypto is maturing
Crypto gives users some significant advantages. You get a payment rail, potentially anonymous transfer, and a distributed peer to peer network. The issuance doesn’t come from a government, and the network is secured not by human decisions but by math.
But how do you accurately price an asset where every user is relatively anonymous, distributed, and international? How do you know the price you pay is the right one?
Price discovery is a fundamental part of every secondary market on the planet, including crypto exchanges. Price discovery helps to give an accurate value of an asset based on prevailing market information.
Every Bitcoin holder and trader relies on price discovery for buying and selling decisions. They rely on it for measuring their performance, determining taxes, and for accurate payments. And through their trading activities, they are also part of the price discovery process.
Price discovery helps shape the entire altcoin and token market where ETH and BTC are used for purchases and funding.
As the product and service offerings in crypto continue to grow, the accuracy of the price discovery mechanism will continue to improve and mature.
MicroStrategy helps price discovery in Bitcoin
Markets are described as discounting mechanisms because prices reflect the expectations of buyers and sellers about the future. 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.
As crypto has evolved, new products and services have expanded. And all of these 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’s also represents an interplay between derivatives like futures, options, and stablecoin arbitrage flows.
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 in these products reflects in part the sum total of hedgers and speculators in assets with futures and options exposure.
Today you will hear how options volume is bullish or bearish for BTC based on the put/call ratio. Futures volumes and contract dates and prices are used by the press to extrapolate expectations about BTC’s behaviour in the future.
These reports influence readers trading the spot or cash markets on exchanges.
Stablecoins arbitrage out BTC price differences
Stablecoins have played an important role in the price discovery in crypto as well. In the ICO boom period through 2017, Dan Matuszewski described how large traders used Tether to quickly arbitrage from the US to China. During that period, the market was still relatively young and unsophisticated, providing large price disparities between different markets. And big opportunities.
By using stablecoins in this manner, price disparities in BTC were reduced around the globe.
Today, stablecoins are among the fastest-growing areas in crypto, with USDC doubling its volume in August 2020 alone. Stablecoins provide faster access around the cryptosphere, making arbitrage more efficient. This reduces price differences in the leading cryptocurrencies like BTC, ETH, XRP, and others around the world.
On Ethereum, the platform is increasingly shaped by the various smart contract-based protocols. The explosion of stablecoins has increased traffic and fees on the platform. And the rapid expansion of DeFi and yield farming has also added significant demand shaping pricing.
6,000 projects provide demand for ETH and BTC
The explosion of DeFi is also part of the pricing environment. Various reports highlight that the amount of ETH and BTC on exchanges has dropped slightly as it is moved from exchanges into the DeFi space. DeFi activity creates a demand-pull for ETH and BTC, where it is used in various ways.
On Bitvo, you can buy the major well-established cryptocurrencies like Bitcoin, Ether, XRP, Litecoin, DASH, QCAD, and others. But if you want to participate in the more speculative areas in the market, you have to buy BTC and ETH and take those to an alt exchange.
Over 6,000 token and alt-coin projects typically trade pairs using BTC or ETH.
A Canadian client would come to Bitvo, exchange CAD or QCAD for ETH, then move that to their wallet and go to an altcoin exchange to buy a token or altcoin. These altcoins are subsequently used for staking in protocols like Compound or Uniswap.
DeFi the speculative version of price discovery
DeFi represents a significant experiment with numerous projects that revolve around staking and yield farming. ETH and BTC are used to buy altcoins that are staked to earn yields from automated market makers. With several billion roaming around this space, DeFi has become part of the leading cryptocurrency price discovery mechanism.
DeFi also demonstrates the difference between a maturing price discovery process and one that is still new. While Bitcoin volatility has been exacerbated by the addition of leveraged trading, it has generally moderated over time.
Various projects in the DeFi space like the infamous Yam go to $150 one day and zero the next, demonstrating its risks. Or the notorious SushiSwap saga where prices were dependent on a variety of unknowns, including the integrity of the anonymous founder.
The influence of BTC fund flows
Funds are another source of price signalling. Fund flows provide an indication of the expectation 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 forms of funds, like hedge funds, help to 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.
Crypto miners are one of the original elements in the price discovery process. Mining rewards and the minting of new coins provides a constant, but dwindling supply.
A change in the mining rewards like the 2020 halvening helps to shape activity around the protocol. But it is the ongoing securing of the network without human intervention that adds confidence in the system. Confidence is an important factor in price discovery.
The dynamism of crypto price discovery
Prices aren’t simply supply and demand based. They are dynamic feedback loops involving an array of financial products and signals.
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 which 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 and therefore helps with wider adoption as a currency and payment medium.
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.
And that means you can buy, sell and trade Bitcoin, Ether, XRP, Litecoin, Dash, and others with confidence.
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