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Stock pricesBitcoin price is in a slow controlled descent with frequent spikes to the upside developing. Market orders are streaming through the exchanges like a ticker tape and buy limit orders fill the orderbooks down to $290. We look at arbitrage trading in the Bitcoin exchanges and consider options for trend in the coming days.

Bitcoin Price Arbitrage
Bitcoin Price Analysis
Summary
Comments

Bitcoin Price Arbitrage

Many thanks to all the readers, supporters and cynics alike, who had responded to Sunday’s article about manipulation in the exchanges. It’s only by kicking the hornet’s nest that discussion about the many uncomfortable truths about centralization and opaque trusted third parties can begin.

Some readers agreed, and substantiated claims of manipulation and collusion. Others accused the writer of being a disgruntled trader, a conspiracy theorist, or for lacking basic comprehension of financial markets. Allow the writer, contrary to his modest nature, to state for the record that he’s a trader with over five years experience in forex, commodity and equity markets. His trading experience extends to futures markets, options trading as well as options writing. He’s one of the 5% most-subscribed members at Forex Factory that has in excess of 300k members. So, objectively, the writer cannot be called a spring chicken when it comes to markets and trading.


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Recap

Sunday’s article has become unwieldy to read since the number of comments, and back-and-forth discussion is voluminous. For the sake of clarity the article’s position is reiterated:

Objection is made to the fact that the Bitcoin Foundation has the self-proclaimed brief of looking after the health of the Bitcoin ecosystem, while most of the centralized exchanges, seeking legitimacy, are Bitcoin Foundation members. Conflicts of interest arise. Some of the exchange bosses even sit on the Bitcoin Foundation board. More conflicts of interest.

Currently, we have a situation whereby the active collusion (not arbitrage – we’ll get to this in a minute) between exchanges has pulled the Bitcoin price down to levels where many smaller miners are throwing in the towel due to unprofitability. This is bad for diversity and decentralization of the Bitcoin network – of which the Bitcoin Foundation calls itself custodian.

That there is collusion and manipulation in the exchanges – and by the exchanges themselves – is not something the writer doubts. It remains to be proven – and the burden of proof falls to the exchanges. Of course, they don’t have to prove anything – granted – but many community members are challenging them to come clear. Regardless of their response, the fact remains that their lack of transparency and centralization renders them untrustworthy. Traders have the option to vote with their feet. The blockchain allows for decentralized exchanges. The centralized exchange market is by no means the only option, or even a necessary compromise as is the case with, say, the Gold and forex markets.

Bitcoin Price Arbitrage Myth

In an attempt to explain the uncanny coordination of exchange price movements many readers ascribed the phenomenon to “natural market arbitrage”. Some even felt it necessary to explain what arbitrage is. They did so in exasperated tones as if explaining the principle of cause-and-effect to a child. After some time in the market any trader eventually understands the difference between pure and risk arbitrage – it is an apparent opportunity for profit and can be lucrative when taken advantage of timeously. However the example provided by many – as an explanation of why the exchanges prices move up and down in tandem – is not, by any realistic measure, an example of pure arbitrage but of pure horse manure.

Pure arbitrage in the Bitcoin exchange market is not viable because of the slow transaction mechanism imposed by the blockchain. “No, no – you don’t understand Khaosan… separate wallets held at separate exchanges, savvy?” As a potential strategy for profiting from differences between exchange quotes it sounds very clever, yet, any trader trying to apply arbitrage strategy in the manner suggested will soon, with a steady stream of losses, abandon it as unprofitable. Here is a simple illustration of why the exchange arbitrage example provided by readers is not viable:

Let’s assume an arbitrageur has $100,000 and 100 BTC at Bitstamp and $100,000 and 100 BTC at BitFinex. Let’s assume a starting price of $310 BTC/USD at both exchanges

Bitstamp
100 BTC
100,000 USD
total holdings (in USD @ $310): $131,000

BitFinex
100 BTC
100,000 USD
total holdings (in USD @ $310): $131,000

1) A big seller executes a large order on Bitstamp. Bitstamp’s price goes to $300 while BitFinex remains at $310.

2) The arbitrageur, spotting his “opportunity”, buys 100 bitcoins at Bitstamp for $30,000 and sells 100 bitcoins at BitFinex for $31,000 (let’s assume spread equals zero). He now has $1,000 “profit”:

Bitstamp
200 BTC (@ $300 = 60,000 USD)
70,000 USD
total holdings (in USD @ $300): $130,000

BitFinex
0 BTC
100,000 + 31,000 USD
total holdings (in USD @ $310): $131,000

Eh? You think there’s a mistake, but this is what readers painstakingly explain to be arbitrage!

Let’s continue, maybe something material changes and miraculously generates profit…

3) Market activity continues and price drops to $295 on both exchanges.

Bitstamp
200 BTC (@ $295 = 59,000 USD)
70,000 USD
total holdings (in USD @ $295): $129,000

BitFinex
0 BTC
100,000 + 31,000 USD
total holdings (in USD @ $295): $131,000

His $1000 arbitrage “profit” at Bitstamp is gone.

4) Market activity continues and price drops to $260 on both exchanges.

Bitstamp
200 BTC (@ $260 = 52,000 USD)
70,000 USD
total holdings (in USD @ $260): $122,000

BitFinex
0 BTC
100,000 + 31,000 USD
total holdings (in USD @ $260): $131,000

The notion of arbitrage is questionable…

In fact, our arbitrageur best forget that misapplied nonsense he heard about arbitrage and do the sensible thing in a Bitcoin downtrend: convert BTC to USD and wait for confirmation of a trend change. He sells all BTC at $260.

Bitstamp
0 BTC
70,000 + 52,000 USD
total holdings (in USD @ $260): $122,000

BitFinex
0 BTC
100,000 + 31,000 USD
total holdings (in USD @ $260): $131,000

5) Market activity continues and price drops to $200 on all exchanges.

Bitstamp
0 BTC
70,000 + 52,000 USD
total holdings (in USD @ $200): $122,000

BitFinex
0 BTC
100,000 + 31,000 USD
total holdings (in USD @ $200): $131,000

Had he held the 200 BTC (instead of selling at $260) his Bitstamp account balance would have been:

Bitstamp
200 BTC (@ $200 = 40,000 USD)
70,000 USD
total holdings (in USD @ $200): $110,000

(compare to the USD-only balance at BitFinex = $131,000)

Post-Disaster Debrief

Pure arbitrage works well between mismatched futures and spot contracts because the same broker will accept immediate settlement of both sides of an arbitrage trade. Applying the principle of arbitrage to two currency accounts held at different exchanges is not only impractical – it’s comical in its stupidity.

Here’s a Bitstamp chart with BTC-e‘s price superimposed in purple. Arbitrage traders are apparently failing to take advantage of price differences for stretches lasting for several hours and even days!

Bitstamp BTCe arbitrage myth

That anyone actually believes that there are people who have been doing this out the on the exchanges, is about as sensical as the widely held misconception that Bitcoin merchants drive the Bitcoin price down. (The logical implication of this argument is that global merchant acceptance drives price down to $0 BTC/USD).

What is really puzzling is how people who don’t understand a mechanism or principle can speak with absolute confidence as if it’s just clear as day – and then get it so wrong that they’d trade themselves a hole in the pocket if they actually went and did the thing they crow so roosterly about.

If you believe in things that you don’t understand then you will suffer.
– Stevie Wonder, Superstition

Bank Trader Insider Explains How Banks Make Market and Use Algos to Set Trend

What do readers think? Please comment below.

[divider]CCN[/divider]

Bitcoin Price Analysis

Time of analysis: 08h00 UTC

Asian Session

At the daily timeframe RSI divergence is hindering additional decline. Traders have by now realized that the exchange bots don’t honor these technical signals, so RSI divergence by no means excludes decline below the body of the candle at 5 October. Presumably one of the larger institution analysts will notice this and inform the exchanges.

RSI divergence is illustrated with a solid red line below price and the diverged RSI in the bottom frame.

Bitstamp Daily Chart

Bitstamp bitcoin chart daily 4nov2014

Bitstamp May 2014 consolidationThe Bitcoin price is in a controlled descent. It strongly resembles the slow decline of May 2014 prior to the surge up to $680. Had this been any other market I would have advised that traders scale into a long position. What prevents me from making this recommendation here is that there are sharks in the water. The apparent action of herding small-fish traders into the expectation of an advancing move cannot be trusted.

It appears that this is what the largest players are setting up here – a moon-rocket – but they can easily switch on the bear-bots and disown many smaller traders of their bitcoins at the critical moment.

Advice is thus as follows:

  • Wait patiently. Don’t preempt the move.
  • Be ready to go long but don’t commit to it until a surge up begins.
  • If the largest players want to ignite a rally here then the wave structure since the $275 (Bitstamp) low argues for a strong wave to $400 and beyond.
  • There will be plenty of pips on the way up, so get in once any surge to the upside pulls back in a retracement.

Bitstamp Hourly Chart

Bitstamp Bitcoin chart hourly 4Nov2014

The level of the daily 20-period moving average is indicated by the dashed horizontal green line at $357.

Summary

Wait for the largest players to show their hand. If they want to spark a rally from current levels during the coming days (within the next 5 days) then price action will draw long green candles with little pullback. Get in on one of these pullbacks.

Alternatively, if this is a trap, expect to see $290 or lower. The banks and investment funds conceivably want the lowest possible price to entice their customers into their new-fangled and regulated Bitcoin ETFs.

[divider]CCN[/divider]

CCN hosts a Bitcoin Price chart and metrics.

Readers can follow Bitcoin price analysis updates each weekday on CCN. In-depth analysis articles are published every Sunday.

Disclaimer

The writer is invested in Bitcoin. Trade and Investment is risky. CCN accepts no liability whatsoever for losses incurred as a result of anything written in this Bitcoin price analysis report.

Bitcoin price charts from TradingView.
Images from Shutterstock.

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Posted by Venzen Khaosan

Market analyst and Open source developer with a keen interest in blockchain technology, consensus mechanisms and the decentralizing effect. He has found a solution to the PKI mechanism. Email me to discuss.