Crypto: why your usual FX pricing techniques might not be best
In May 1977, Thomas Bertrand Lance, the Director of the Office of Management and Budget in Jimmy Carter's 1977 administration, coined the famous phrase "If it ain't broke, don't fix it.”
In some cases, this phrase makes a fair point - if something is working well, then there is no reason to spend time or money on fixing it. Still, in other cases, it can mean accepting the status quo and settling for mediocre (or, in the case of crypto, expensive) results.
Listening to various LPs to form rates in efficient markets without applying pricing intelligence may not be optimal. Yet, it is undoubtedly an option since liquid assets and markets are a little more resistant to manipulation and arbitrage. However, as it stands, crypto is an entirely different environment.
The more liquid a market is, the more stable it is. With pseudonymous players worldwide and little regulatory framework, crypto markets have a history of price manipulation. But the lack of accountability is only half of the story; equally
important is the liquidity environment that can make arbitrage and manipulation all too easy. An illiquid market can allow a single large actor, or group of actors, to manipulate the price for their benefit. Lower liquidity also leads to less stable prices for an asset, and dips in price may result in flash crashes.
This limited liquidity combined with volatility, underdeveloped links between crypto markets and retail-esque flow means you can’t just assume the top-of-book for one market to be a reliable guide for the actual price.
To participate effectively in the crypto markets, you must carefully consider applying price formation and risk management intelligence to the rates you listen to from the exchanges. This provides you with much-needed protection from arbitrage and volatility, whilst also giving you the best opportunity to monetise your business. When faced with new frontiers of the crypto wild west where assets are continually arbitragable, optimising your rate needs to be at the top of the agenda.
