Liquidity and Price Informativeness in Blockchain-Based Markets


Blockchain-based markets impose substantial costs on cross-market trading due to the decentralized and time-consuming settlement process. I quantify the impact of the time-consuming settlement process in the market for Bitcoin on arbitrageurs activity. The estimation rests on a novel threshold error correction model that exploits the notion that arbitrageurs suspend trading activity when arbitrage costs exceed price differences. I estimate substantial arbitrage costs that explain 63% of the observed price differences, where more than 75% of these costs can be attributed to the settlement process. I also find that a 10 bp decrease in latency-related arbitrage costs simultaneously results in a 3 bp increase of the quoted bid-ask spreads. I reconcile this finding in a theoretical model in which liquidity providers set larger spreads to cope with high adverse selection risks imposed by increased arbitrage activity. Consequently, efforts to reduce the latency of blockchain-based settlement might have unintended consequences for liquidity provision. In markets with substantial adverse selection risk, faster settlement may even harm price informativeness.