The question on everyone’s mind after today’s run up in the price of bitcoin, was “why did it happen?” There has been a predictable rush of articles. Barrons headline summed it up: Why Did Bitcoin Suddenly Surge?  It’s a Mystery.

A better question, is how could you have profited? At the very least, how could you have NOT lost money, if you were trading during this period today?

Let’s start answering those questions by analyzing the market data from the 24 hours surrounding the initial rally.  The following graph shows the movement of the market using the CoinRoutes platform, where the blue line is the consolidated best bid and the orange line is the best offer:

As you can see, the rally was extremely sharp and consisted of three sharp upward spikes, the third of which faded almost immediately afterwards.  It is worth noting that I have often been asked why such sharp moves occur in Bitcoin, and my answer is invariably the same: Many crypto investors are ignorant of financial markets and others are manipulative;  in both cases, the method of asking for quotes from many brokers leaks information to the market that causes sharp price moves. This almost certainly happened today. (As a counterpoint, at CoinRoutes, we advise our clients to trade algorithmically, using our system to conceal the extent of orders while working them on many exchanges over a period of time.)

The chart below zooms in on the crucial 45 minute period when the three sharp up moves took place:

Notice that each of the first two spikes featured situations where the best bid was far higher than the offers available, across the competing exchanges.  During both of these moves, the exchange with the best bid was predominantly LMAX, which is known to predominantly feature quotes by market makers. Those market makers probably sold Bitcoin to an aggressive OTC buyer, and needed to buy back those Bitcoin, and the market responded.  It is noteworthy that the arbitrage gap during the second move upwards reached over $300 per bitcoin; this occurred when the best bid reached $4782, compared to offers on other exchanges at just over $4465. This type of gap has become quite rare due to arbitrageurs, so it is noteworthy, and indicative that the buyer was able to overwhelm readily available bitcoin used for the purpose of arbitrage.

The third spike upwards was quite different, insofar as there was much less of an arbitrage opportunity during the rally.  While it did create some opportunities, the maximum arbitrage spread was just under $70 and the duration was much shorter than in the previous spikes.  This is indicative that the short positions at the market makers was probably already covered, and this round of buying was created by momentum followers.  That would explain why, once the rally paused, it almost immediately began to reverse and all the gains from that third spike were erased within a fairly short period of time.

During this market volatility, clients of CoinRoutes were quite well positioned.  In addition to having access to the information described above, CoinRoutes algorithms are designed to handle these situations.  If a client was buying Bitcoin via an algorithm during this period, they would have been able to avoid overpaying by either directing their orders to the exchanges with lower prices or relying upon the market to correct the temporary excesses.  (and the opposite if selling) This would have been true, even if the client only had accounts on exchanges that were only trading too high or low for their order, due to mean reversion. Mean reversion, in this context, is defined as the prices on the exchanges tending to converge with each other.  As a result, when one exchange is much higher or lower than their peers, that situation almost always reverses relatively soon.  To understand, look at the pie charts below, which shows the relative time each exchange spent on either the Best Bid or Best Offer during the 24 hours surrounding the rally:

As you can see, there was a healthy competitive market at work, where the exchanges rotated quite often between being on the best bid, best offer or neither.  This type of market dynamic means that there is a significant value to knowing where each exchange’s quotes are positioned within the overall market, when implementing a trading strategy.

In conclusion, there are three takeaways in this article for crypto investors:

1. Trading on single exchanges or with single counter parties is dangerous, as it is possible to buy too high or sell too low.  This is particularly true when large orders exhaust the available liquidity at individual markets.
2. Traders that use algorithms have a significant advantage over those that do not (if those strategies are informed by consolidated book data).
3. Access to consolidated market data, such as described here, can be extremely helpful in understanding the price moves and anticipating what might happen next.