Cryptocurrencies: Price & Pairs Trading

Cryptocurrencies are growing exponentially in their number and value. It is time to examine price and hunt for opportunities.  
 

Comparing cryptocurrencies to traditional government-issued currencies may seem a stretch at first, but really does not require much effort when you consider that few countries back their currencies with gold or any other valuable commodity. The key to acceptance of any form of money — fiat currencies or the new cryptocurrencies — is trust. 

Development and use of blockchain technology has enabled many organizations to issue virtual currencies that in some regions of the world are the equal of government issues — lacking only the government stamp of approval for complete authority.

Cryptocurrencies have an important added advantage over money issued by most countries in that there is no monetary authority attempting to lower the value of the currency to assist a country’s export trade. 

Early in the process of the development of blockchain use, one might have imagined that the fate of cryptocurrencies would be similar to that of any such fad. However, the number of new cryptocurrencies continues to increase. While the debate over the value of bitcoin and cryptocurrencies continues, from early on in the development of bitcoin and other cryptocurrencies the underlying blockchain technology has been a hit. The number of virtual currencies now trading smoothly as legitimate investments and a means of capital raising has established them as a new asset class, if not a growing monetary instrument. There is little doubt that a completely new form of money has been created.

Although bitcoin had an early lead in pricing and trading, “Cryptocurrencies” (left) shows that other currencies have entered the field with strong competition for growth in pricing and total value. The randomly chosen sample of eight cryptocurrencies including bitcoin describes a year’s cumulative percentage change in price in which bitcoin has the slowest rate of price change when calculated on a daily cumulative basis. It appears that bitcoin also experienced the lowest price volatility during the 12-month period that began on March 7, 2017.

Price Changes & Value

While the price change for bitcoin rises to approximately 200% for the year, several currencies are in the 800% range and several others at 400% to 500%, when measured on a daily cumulative basis. 

The picture does shift somewhat when the percentage price changes start at the first of January 2018. As shown on “Cryptocurrencies’ 2018 performance” (below). Ripple’s price changes begin to sink while the stability of bitcoin pricing puts it in the middle of the group at the first of March 2018. Those of you closely following bitcoin pricing know that it actually grew by well over 1,000% in 2017 at one point, but the daily accumulative method allows us to better compare multiple cryptocurrencies that are at different stages in their evolution (see “Bitcoin & Ripple price changes,” left).

The charts present closely coordinated price changes for this group of cryptocurrencies, which suggests that various pairs trades in the sector are possible. Various potential pairs trading opportunities are shown in “Crypto pairs” (page 73). We examine the relationships between Bitcoin and Monero, Ethereum and Litecoin and Ripple and Lisk.

Crypto Pairs

The pair trade charts are not presented as suggested current trades, but as notices to traders that several virtual currencies have close price movements. This means that at any time in the future if there is a significant spread between the two price changes, a pairs trade opportunity may exist. The trade depends on the two prices closing the gap as they have in the past.

One potential problem noted by one crypto trader is a lack of liquidity outside of bitcoin. Currently, it is necessary to trade every cryptocurrency against bitcoin, so a pairs trade of Ripple and Lisk, for example, would require trading each against bitcoin to establish a long position in one and a short in the other. This could become expensive but as liquidity improves, it will likely become unnecessary for the top cryptos. 

A major need currently exists for futures contracts, options, and exchange-traded funds (ETFs) in the cryptocurrency market. At present, the pricing of the currencies shown on the charts presented above would make even simple pairs trading difficult. For the eight currencies in our sample, the beginning and ending prices (March 2017 to March 2018) are shown on the table to the right.

The pricing of ETFs, is typically arranged so that the price per share is in an easily traded range similar to the price of a share of common stock. The ETF price would follow the cryptocurrency price changes closely since that is the normal objective of an ETF.

In addition to the pairs trades suggested above, the price changes show potential for Stellar–Ripple, Monero–Zcash, and Bitcoin–Zcash combinations. All of these are worth observing in the future in case a gap occurs between the two price changes. For a closely coordinated pair, the distance between the two prices should grow smaller, giving the trader a relatively low-risk profit.

Crypto Derivatives 

In the recent past, it seems that bitcoin has been considered to have a relatively volatile price, while the charts shown above appear to indicate the opposite. Cboe Futures Exchange (CFE) and CME Group now have futures trading for bitcoin, with additional cryptocurrency futures planned. On March 9, the prices quoted for CFE bitcoin futures (XBT) included was $9,040 for the March 2018 contract; $9,100 for the April 2018 contract; $9,120 for the May 2018 contract; and $8,950 for the June 2018 contract. The price shown in the previous table is $11,504. It seems that the futures market is forecasting a dropping price for bitcoin. 

Perhaps in the not-too-distant future we will have a full complement of futures contracts, options, and ETFs for all major cryptocurrencies. Until that time, we can trade possible movements in bitcoin. Also, we want to keep the potential pairs trades in mind, with Stellar, Lisk, Ripple and Litecoin playing lead roles — looking for price separations and predicting a return to closeness to reduce the price gap for a spread profit.

In terms of volatility, bitcoin futures may give the appearance of high volatility simply because of high dollar prices. For example, on Dec. 18, 2017, the March 2018 bitcoin CFE contract, BGH18, ranged from a high of $20,500 to a low of $18,490. On Feb. 6, 2018, the price range was $7,780 to $5,940, and on March 9, 2018 from $9,450 to $8,380. If these prices seem unruly, try dividing each one by 1,000. This will bring them down to a size comparable to a potential exchange-traded fund’s price per share – comfortable for trading with price changes that match changes in the futures contract.

As mentioned earlier, cryptocurrencies are at present trading outside of government influence or interference, but it would be possible for a country – perhaps an emerging nation – to adopt a virtual currency as its official money. Such a plan would avoid the need for massive printing and minting real currency and — issued in small denominations — would provide the liquidity for normal business.

This may seem far-fetched for Americans, but there are numerous countries experiencing hyperinflation that are close to losing faith in their domestic currency. While it may be too early to make assumptions regarding the basis between certain cryptocurrencies and trade them in earnest, it is certainly not too early to monitor their interactions and to be prepared for the trading opportunities they present.