It has long been believed that investors possessing inside knowledge help drive cryptocurrencies’ price volatility, and a number of academic papers have been published on this topic. This is why Coinbase’s intention to regularly publish in advance a catalog of tokens being assessed for listing on its prominent trading platform is noteworthy.
Coinbase’s plans, announced in an April 11 blog along with 50 crypto projects “under consideration” for Q2 2022, could help tamp down the pervasive speculation that surrounds small-cap tokens. Meanwhile, this can help alleviate industry concerns about “information asymmetry,” which typically occurs when one party to a transaction — a seller, for instance — is much better informed than another transactional party, such as a buyer.
Last week’s pre-list, which included 45 ERC-20 tokens on the Ethereum blockchain network and five SPL tokens on the Solana network as well as future token lists, is meant to “increase transparency by providing as much information symmetry as possible,” the United States’s largest crypto exchange explained.
Will it really smooth out the crypto-investor playing field, though? “It can be a step in the right direction,” Lennart Ante, co-founder at Blockchain Research Lab gGmbH and author of a research paper on information asymmetry in Bitcoin (BTC) transactions, told Cointelegraph. “In theory, this reduces information asymmetry and, thus, the price effect at the time of the listing.”
“More transparency is always welcome, obviously,” Daniele Bianchi, associate professor in finance at the School of Economics and Finance of Queen Mary University of London, who has published research on crypto price swings, told Cointelegraph. That said, “information asymmetries and adverse selection are still pervasive in cryptocurrency markets,” and that isn’t likely to change anytime soon.
Indeed, a mere day after Coinbase’s listing announcement, reports surfaced on Crypto Twitter that one crypto wallet holder, possibly an insider, probably had pre-knowledge of Coinbase’s new listing candidates, and may have made a tidy profit trading on some of those tokens. According to crypto influencer Cobie:
“Found an ETH address that bought hundreds of thousands of dollars of tokens exclusively featured in the Coinbase Asset Listing post about 24 hours before it was published, rofl.”
New distortions from institutional investors?
Be that as it may, Coinbase’s announcement serves as a reminder that the industry continues to struggle with the problem of asymmetric, or unbalanced, information and it raises questions.
Are information asymmetries really driving huge price swings in cryptocurrencies, as commonly believed? If so, is this undermining investor confidence in the system? If something is amiss, what might help fix things? And, what about Coinbase’s recent announcement, isn’t this an encouraging move on the part of an acknowledged industry heavyweight?
Information asymmetry is a real crypto sector problem, driven by relatively low market capitalization, a concentrated ownership structure and a highly fragmented and multi-platform market structure, said Bianchi. Moreover, it’s no longer just “whales” and crypto miners who may be manipulating markets, he told Cointelegraph:
“The investment landscape is changing and more institutional investors — either specialized or multiasset — are coming into the marketplace. In other words, there is a new type of sheriff in town with the potential to benefit from naïve retail investors.”
The low liquidity level of many crypto projects makes them vulnerable to price manipulation, added Bianchi. “Liquidity is key here. Outside of the top 100 by market capitalization, a trade of a few million USD can easily generate significant price swings at the expense of retail traders who typically have poor market timing skills.”
Some others concur. “The cryptocurrency market is, in fact, the perfect environment to exploit asymmetric information,” Raj Kapoor, founder of the India Blockchain Alliance, told Cointelegraph, given that “it is not completely transparent and part of a fragmented ecosystem.” Rather, it’s a mix of web-based brokers, peer-to-peer exchanges and major exchanges that provide liquidity to their smaller counterparts, said Kapoor, adding:
“Those who have the information and can time the market, make money and drive the prices. Inconsistent and non-aligned crypto exchange regulation fosters this environment.”
“There is almost always a circle of people who have the information in advance and can or could act accordingly,” added Ante. This includes events like exchange listings, regulatory changes or even tweets from influential people like Elon Musk.
“One of the biggest asymmetries is that the anonymous developers know their own identities and intentions, but buyers don’t,” Douglas Horn, chief architect of Telos, a blockchain platform, told Cointelegraph.
“Another type is market manipulation by whales who know that their big sell-walls are just there to crush the price so they can end up acquiring more of a coin without any new investment, but the majority of investors do not. Both of these situations cause big swings in market value,” said Horn.
But, is it really problematic? Cryptocurrencies are a small subset within a much larger legacy financial system, after all, where information imbalances have proliferated for many decades.
At the core of traditional finance
“Information asymmetries are at the heart of financial markets,” James Angel, associate professor at Georgetown University’s McDonough School of Business, told Cointelegraph. There are “huge asymmetries” between product issuers and investors, brokers and clients, as well as in trading markets, he said, adding:
“Equities have always been extremely volatile and always will be for a simple reason: Nobody knows what they are really worth because no one knows what the future holds.”
The same applies to cryptocurrencies. In Angel’s view, their mammoth price swings are a “natural artifact” of the uncertainty over tokens’ true value, which isn’t so unusual given that we are in the middle of a technological revolution. Indeed, “it feels just like 1999 all over again,” he said, referencing the dot.com boom when tech-based equities grew at exponential rates.
Today, there are many new “promising entrants” in the crypto space, Angel continued, and not all of them will succeed. “Time will tell which of them are the next Google versus the next Pets.com. Given the lack of regulation, there are undoubtedly lots of hijinks going on as well.”
According to Kapoor, information asymmetry remains a significant problem for the crypto industry. Many mature, centralized and traditional markets — like equities — are symmetrically aligned, he said. “Not so trading in cryptocurrency.” Crypto markets have a “highly fragmented multiplatform structure; the problem is not going away anytime soon.”
Others suggest, however, that the cryptoverse with its distributed digital ledgers that are open for all to see and is less riddled with information asymmetries than traditional finance.
Yes, “information asymmetries are an intrinsic part of markets for assets with uncertain value,” and that includes many crypto projects, Emiliano Pagnotta, associate professor of finance at Singapore Management University, told Cointelegraph, but blockchain projects differ from traditional enterprises too:
“A cryptocurrency like Bitcoin is not subject to asymmetric information about cash flows, managerial decisions, mergers, earnings or several essential variables affecting firms’ securities.”
Both Bitcoin and Ether (ETH) have evolved in a transparent open-source process too, Pagnotta added, with updates and innovations discussed openly months and sometimes years in advance.
That said, weaknesses haven’t been completely eliminated, and “there can still be significant asymmetric information related to external factors such as regulation. For example, Chinese officials had advanced knowledge of the decision to crack on all Bitcoin mining before the corresponding announcement in the first half of 2021.”
That, presumably, would have provided officials or the government an opportunity to unload their BTC holdings before market prices plummeted. “Regulatory uncertainty is probably the most critical barrier to investor confidence, in my view,” said Pagnotta.
Is Coinbase leveling the playing field?
What about Coinbase’s announcement of 50 crypto projects that could be heading for a Q2 listing on its exchange: Is that a blow struck in the interests of transparency?
It was “a step in the right direction,” said Pagnotta, helping to even out information imbalances. Up to now, it’s common for investors to open exchange accounts “merely to gain access to an unlisted token on their primary exchange,” he said. This is cumbersome, time consuming and not very efficient.
“For the public at large this will not change the situation much,” opined Bianchi. When a coin makes Coinbase’s pre-list, algorithmic traders or market makers can still “front-run retail investors and take profits without necessarily waiting for the so-called ‘Coinbase effect.’” More transparency in the listing process is desirable, of course, “but it does not solve the issue.”
As for the reports that someone, perhaps an employee, may have been trading in advance of the April 11 blog post, Horn said that there really isn’t too much that can be done about actions like these. “The listings of big companies like Coinbase have always been excellent opportunities for insider trading because anonymous trading is easily accessible — making enforcement impossible.” It’s not an ideal situation, but it can’t be easily stopped “so there’s not much point in getting upset about it.”
Coinbase could do some small things. “They can possibly publicly commit to penalize/fire any employee caught trading in advance of the publication list if they are not doing so yet,” said Pagnotta, as well as restricting which assets are investable for employees and other things like that.
Would more regulation help? Basically, “such trading lies outside of the scope of regulatory agencies, in my view,” Pagnotta said, noting that the United States definition of insider trading, Rule 10b-5 of the U.S. Securities Exchange Act of 1934, requires “buying or selling [of] a security,” and at this point in time ERC-20 tokens “are not a registered security.” In other words, U.S. insider trading rules may not apply.
Needed: more adoption, trading volume
All in all, the crypto sector may find it difficult to eliminate information asymmetry in the short run without losing the decentralized nature of cryptocurrency markets. More transparency, like that offered last week by Coinbase, is helpful, but they can only do so much.
But, the longer-term outlook may be more positive “with more professional investors coming into the marketplace and regulators assuming closer oversight,” Bianchi told Cointelegraph, adding:
“We need more adoption, less ownership concentration and more volume trading to improve the price discovery process and market quality as a whole.”