High Frequency Trading in Crypto Markets

We have previously been covering the large scale cryptocurreny adoption on Wall Street. Things now appear to be getting that much more interesting as a number of High Frequency Trading (HFT) firms are entering the fray.

This was disclosed in an article in the Financial Times where they claimed that several of these HFT firms have started operations in cryptocurrencies. One of those that have been reported is DRW which buys and sells the coins through a subsidiary called Cumberland Mining.

For those who may not know, Cumberland took part in the government's auction of 20,000 Bitcoin in 2015 that were seized from the Silk road. Proprietary trading firms such as Cumberland will act as counter-parties to other institutions such as hedge funds and family offices.

Profitable Arbitrage

It was not just DRW that has entered the cryptocurrency markets. Other firms such as DV Trading, Jump Trading and Hehmeyer trading also have cryptocurrency divisions.

One of the driving forces behind these moves appears to be the large amount of volatility that is present in these markets. From the Chinese ICO ban to the recent $6,000 all-time high, Bitcoin has had extreme price swings. This is compared to the traditional markets where the HFT operate which have had rather muted gains over the past year.

HFT firms have traditionally been operating in traditional equity markets where they made use of advanced algorithms to make a market for institutional clients. Given the volatility in the Bitcoin markets, the spreads and profits that an HFT firm can make by placing bulk orders is quite substantial.

Indeed, this was covered earlier this year by a Bloomberg article that disclosed that Bitcoin HFT in China found the opportunities in Bitcoin really profitable. These Chinese HFT traders used algorithms to identify mispricings and arbitrage opportunities across numerous exchanges in China. This is particularly profitable in the Bitcoin space as there are relatively minor transaction fees and the trading Algorithms can run 24/7 every day of the year.

However, given the recent moves by the Chinese government to shut down all of the Bitcoin exchanges, there is no doubt that these HFT firms will have to cease operations. This means that traders in other jurisdictions such as the United States could replicate their tactics across exchanges.

Impact of HFT on Volatility

There are varying opinions as the the impact that this HTF trading and their accompanying algorithms will have on Bitcoin volatility. The general notion among most users in the Bitcoin ecosystem is that more institutional adoption and trading will increase the liquidity and hence reduce the wild swings and volatility.

However, there is other evidence that the HFT trading firms can lead to severe price swings when the algorithms break down or misread certain information. This is exactly what happened in the 2010 wall street flash crash where the Dow plunged about 9% and recover within minutes. Many regulators blamed this on the HFT algorithms.

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