A New Perspective on Financial Markets - What Cryptocurrencies and Blockchain Technology can Teach us About Market Microstructure

Abstract

The applications of blockchain technology have grown rapidly in recent years. Governments, central banks, and companies are developing blockchain based projects to improve efficiency and remain competitive. In addition, the markets for cryptocurrencies have grown exponentially. It is therefore increasingly important to understand the market structure of these markets and understand how the design of blockchains affects the costs and usability. Such insights make it possible to gain new perspectives on financial issues, as aspects of their structures differ from traditional equity markets. First, I show that the intraday variation in liquidity on cryptocurrency exchanges resembles that of foreign exchange markets and that bitcoin is highly invenstible. Second, I give a new perspective on the discussion on the optimal tick size. I use the market setting on a cryptocurrency exchange, where the tick sizes are close to zero to show that small tick sizes are detrimental to market quality. I show that a dynamic tick size relative to the price of the asset may be more optimal than the "one tick size fits all" approach commonly found in stock exchanges. Third, I isolate and quantify market frictions and show that a long clearing and settlement time lowers the activities of arbitrageurs and leads to larger price differences. The results are relevant for central banks as they develop digital currencies to increase transaction speed. Lastly, I show that the bitcoin blockchain design inflates transaction volumes and adoption levels and obfuscates the transaction costs. This dissertation shows that the markets for cryptocurrencies can function as useful laboratories to provide new perspectives on long lasting finance issues. The findings have wide implications for users, companies, governments, banks, and regulators.