Sometimes it just pays to have the odd rule in your trading ecosystem to protect you from when things – as they inevitably do – go wrong. The latest to discover this is Japanese crypto exchange Quoine, which this week lost an appeal against a ruling in Singapore that it wrongfully reversed seven crypto trades executed with B2C2.

The issue behind the case were seven Bitcoin-Ethereum trades in April 2017 that were executed while the Quoine system was experiencing a glitch. Because the market data stream was interrupted, B2C2’s fail-safe cut in and it started streaming a price at a level it was comfortable taking on any market risk, in this case it was apparently 10 Bitcoin to one Ethereum as opposed to the then average price of 0.04. Seven trades were executed at that price.

A few thoughts on this.

Firstly, what the exchange effectively tried to do was cancel the trades in their entirety – perhaps it could have tried the re-papering approach that I like so much (yes, I am being sarcastic). The exchange’s argument was that B2C2 knew that the traded price was wrong and it wilfully took advantage of that. The problem here is, how does a computer know when something is wrong if it has no data? A pricing engine, if it is to remain on has to have a default – in this case it was 10. How is the computer to know, in the absence of data, that something hadn’t happened and that this was the real price?

One could argue that the exchange should have a rule about the maximum gap between quotes, but we need to remember this is Bitcoin in 2017 – rather large moves were not uncommon – and as such, who is to say that gap would not have had the circuit breaker at 10? At the very least, if such a rule existed then either B2C2’s pricing protection would be recalibrated to that level or it’s price wouldn’t enter the system and couldn’t be traded upon.

Secondly, I am glad to see the Singapore legal system understands responsibility. I have long argued that all markets should come with a “consenting adults” rule – if you make a mistake, try to rectify it reasonably, but if you can’t, own the mistake. Don’t complain about how unfair it all is like a stroppy teenager. Just as the exchange should have some sort of protection in place, so too should the executing algorithm (or, in fact, the human clicking the mouse). Is it the market maker’s fault that the executing party’s infrastructure is insufficiently controlled? The crypto markets are meant to be “trustless” – that means what you hit is what you get – it’s probably too late to change that now.

Thirdly, the crypto markets do largely reflect OTC markets in their structure and if there is one thing we have learned over the past five years it is the importance of having a rule book so that everyone knows where they stand in such instances. Clearly in this case there was nothing beyond the exchange unilaterally cancelling the trades – an action that Singapore’s Court of Appeal has confirmed was wrong – and this equally clearly was not covered in a rule book, assuming one existed.

There is also, fourthly, a lesson here for the crypto market generally – one it would do well to heed. Liquidity in these markets is fickle and can very easily disappear – don’t be lulled into a false sense of security over the relative tranquillity in Bitcoin at the moment. I understand one of the core tenets of crypto markets is that they are not subject to onerous regulation, but if crypto wants to really become mainstream and institutional at a much bigger level, it is going to have to achieve consensus over how events such as these are dealt with. This is an individual case – it could quite easily become an industry-wide problem.

If the  crypto industry wants a lesson from foreign exchange then I would suggest that the first port of call is a message to the exchange or counterparty if known about re-papering to a more reasonable level. Most people are realistic enough on these matters and while I personally would have made a lot more people stand by trades on SNB Day at 0.60 and 0.50, the fact was everyone seemed to find it acceptable to settle at 0.85 (although I note there is at least one legal case still going on around the re-papering issue).

I accept it’s a hard lesson to learn, but hopefully one of the very real benefits of this ruling in Singapore is that a lot of market participants will take a look at their trading infrastructure and check they have adequate fail safes in place. We hear a lot about making markets safer and I would argue this is the most effective way of doing so – certainly much more than allowing firms to trade randomly and then cry foul every time they make a mistake.

Colin_lambert@profit-loss.com

Twitter @lamboPnL

Colin Lambert

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