Building Trust Takes Time: Limits to Arbitrage for Blockchain-Based Assets

Nikolaus Hautsch; Christoph Scheuch; Stefan Voigt

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arXiv · 1812.00595

Building Trust Takes Time: Limits to Arbitrage for Blockchain-Based Assets

Nikolaus Hautsch·Christoph Scheuch·Stefan Voigt

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Abstract

A blockchain replaces central counterparties with time-consuming consensus protocols to record the transfer of ownership. This settlement latency slows cross-exchange trading, exposing arbitrageurs to price risk. Off-chain settlement, instead, exposes arbitrageurs to costly default risk. We show with Bitcoin network and order book data that cross-exchange price differences coincide with periods of high settlement latency, asset flows chase arbitrage opportunities, and price differences across exchanges with low default risk are smaller. Blockchain-based trading thus faces a dilemma: Reliable consensus protocols require time-consuming settlement latency, leading to arbitrage limits. Circumventing such arbitrage costs is possible only by reinstalling trusted intermediation, which mitigates default risk.

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Nikolaus Hautsch, Christoph Scheuch, Stefan Voigt. 2018-12-03. Building Trust Takes Time: Limits to Arbitrage for Blockchain-Based Assets. https://arxiv.org/abs/1812.00595

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