Distributed Ledger Technology, with its promise of decentralized and swift settlement cycles, comes at the cost of introducing uncertainty due to the unpredictable nature of settlement time, which has negative implications for the investors trading on that venue. One-minute increase in settlement latency leads to a 1.3% increase in transaction cost and a 1.5% increase in price impact.
The World Federation of Exchanges (WFE), the global industry association for exchanges and CCPs, has published novel research that warns of the risks of adopting technologies without trusted third party oversight, such as permissionless Distributed Ledger Technology (DLT), that radically reduce settlement time at the cost of market quality.
The research finds that:
. When adopting Bitcoin blockchain the cost of making a trade increases, and the price reaction to a trade is intensified. For example, a one-minute increase in settlement latency leads to a 1.3% increase in transaction cost and a 1.5% increase in price impact.
. This increase isn’t a rare event, and some of our findings showed that settlement latency can easily vary by over 3 minutes, equating to a 3.9% increase in transaction costs and a 4.5% increase in price impact.
. When there is uncertainty, informed traders will find it more difficult to execute their trading strategies and therefore pricing is less efficient.
Inherent latency in DLT settlement introduces uncertainty into the settlement process due to factors such as overall mining capacity, which affects block validation speed. The WFE finds that this uncertainty discourages investor participation, resulting in a deterioration of liquidity and an increase in transaction costs.
According to WFE, „the policy implications are substantial, especially in shaping the market design of cryptocurrency infrastructure and, more broadly, for exchanges that are considering different methods of speeding up trading time. DLT, with its promise of decentralized and swift settlement cycles, comes at the cost of introducing uncertainty due to the unpredictable nature of settlement time, which has negative implications for the investors trading on that venue.”
„Policymakers and market operators, from regulated exchanges to crypto platforms, should carefully consider this trade-off between near-instant settlement and market quality before introducing DLT. The research reinforces the important role of CCPs and CSDs in overseeing and guaranteeing the settlement process and reducing uncertainty in the timing of settlement. Markets with less uncertainty have increased liquidity and lower trading costs.” – WFE concluded.
Banking 4.0 – „how was the experience for you”
„So many people are coming here to Bucharest, people that I see and interact on linkedin and now I get the change to meet them in person. It was like being to the Football World Cup but this was the World Cup on linkedin in payments and open banking.”
Many more interesting quotes in the video below:
