trading

Bitcoin’s volatility is hitting its lowest level in two years, and it is forcing traders to shakeup their strategy

Quick Take

  • Bitcoin volatility is set to hit a two-year low in the coming weeks
  • That’s putting pressure on high-frequency trading firms, which make money from big price swings in crypto markets
  • If low volatility persists, it might lead to trading firms closing their crypto desks

High-frequency trading firms (HFTs) are shaking up their approach to the crypto market as volatility hits a two-year low. 

In 2017 — the year that brought bitcoin close to $20,000 — cryptocurrency markets were known for their spine-tingling volatility. That kept out many money managers and investors, but it precipitated the entrance of a number of high-frequency trading firms into the market. Volatility was the clear motivator for such firms. But 2018 has ushered in a new regime of low volumes and low volatility that is putting pressure on HFTs to act differently. 

“If trading volumes are lower and spreads are lower, then naturally trading-commission businesses are lower,” said Michael Moro, the chief executive officer of Genesis Trading, a New York-based cryptocurrency market maker. 

Volatility all time lows 

Volatility is a big money-maker for trading firms, which can profit by buying up a given asset at a low price and selling it back to the market at a higher price. When there are more price swings in a given market — i.e. more volatility — then the profit opportunity is larger. At the end of 2017, bitcoin volatility hit peak levels, with daily price swings above 5% and even 10% becoming normal. In addition, the price differences between exchanges trading crypto reached as high as $1,000 during this period.

“When the markets are wild and going left and right, it is not difficult to make money,” Max Boonen, the chief executive officer of B2C2, a market making firm, said in an interview with The Block. 

That’s not the environment today, according to data compiled by The Block. Bitcoin’s volatility is at its lowest level since December 2016.

That’s put pressure on some trading firms, including B2C2. “Any strategy in market making or prop shop is heavily correlated with market volatility,” Boonen, a former Goldman Sachs trader, said. “The profit profile is the volatility in the market.”

As for Boonen, his firm was in financial trouble earlier this year and was looking for a buyer. But improvements in its algorithms have helped the firm stay afloat, Boonen said. 

In 2017, the U.S. equity markets were gripped by a low volatility regime that put pressure on prop shops — those firms that trade with their own capital instead of investors’ money — forcing some to close and others to consolidate. Notably, Virtu Financial bought rival KCG. And Sun Trading was bought by rival Hudson River Trading. 

Volatility is cyclical, and so this calm environment in crypto will likely not last indefinitely. The last time bitcoin volatility was at a level similar to today’s, it sprang up from 1.16% to 5.36% in a month. Still, by the time volatility returns it might be too late for firms that did not adapt to survive. 

“I don’t expect volatility to stay low for long,” said Garrett See, the chief executive officer of DV Chain, a cryptocurrency trading unit of DV Trading. “This is the calm before an explosive breakout.”

To be sure, there are prop shops that are looking to build out their desks despite the current backdrop. DRW, Akuna Capital, and Geneva Trading are among the firms prospecting for new talent

Other opportunities and consolidation

In the meantime, firms are exploring new strategies and business opportunities. Genesis Trading’s Moro said many firms are shifting from simple exchange arbitrage — buying low on one exchange venue to sell at a higher price on another — to more complex four- or five-legged strategies. 

“Selling bitcoin for yen and then buying ethereum with that and then selling it into litecoin,” he said as an example. “The arbitrage opportunities are far more complicated. You have to have access to the exchanges. And bank accounts and FX brokerages to access those markets to get in and out very quickly.” The combination of tools is required to spot the gaps between prices and the different foreign currencies required to profit from it just add another layer of complexity.

The days of simply “buying on Bitstamp to then sell on Bitfinex” are over. As for Genesis Trading, the firm has benefited from its loan business to make up for the slump in trading. The firm has originated $553 million in loans since its inception. “It has been a nice revenue hedge,” Moro said.

As for what happens next, both Boonen and Moro expect consolidation and layoffs akin to what the equities market saw in 2017 and 2018. 

“The name of the game right now is survival and literally just being there,” Moro said.