Building Trust Takes Time: Limits to Arbitrage for Blockchain-Based Assets
49 Pages Posted: 2 Jan 2019 Last revised: 13 Oct 2023
Date Written: January 29, 2021
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.
Keywords: Arbitrage, Blockchain, Market Frictions
JEL Classification: G00, G10, G14
Suggested Citation: Suggested Citation