Building Trust Takes Time: Limits to Arbitrage in Blockchain-Based Markets

Abstract

Distributed ledger technologies replace central counterparties with time-consuming
consensus protocols to record the transfer of ownership. This settlement latency
slows down cross-market trading and exposes arbitrageurs to price risk. We theoretically
derive arbitrage bounds induced by settlement latency. Using Bitcoin orderbook and network data, we estimate average arbitrage bounds of 121 basis points, explaining 91% of the cross-market price differences, and demonstrate that asset flows chase arbitrage opportunities. Controlling for inventory holdings as a measure of trust in exchanges does not affect our main results. Blockchain-based settlement without trusted intermediation thus introduces a non-trivial friction
that impedes arbitrage activity.

Keywords: Arbitrage, Blockchain, Market Frictions

JEL Classification: G00, G10, G14