Mt. Gox Impact Diminishes as Market Price Dissociates

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Update: Feb 17, 1:32p EST

This morning, Mt. Gox announced a technical solution to the bitcoin withdrawal issue is being tested. A timeline for actual reinstatement of withdrawals remains to be seen, though an update was promised by Thursday.

update1

As discussed / expected in our original discussion below, XBT / USD has since climbed on the news and the impact has been more significant at Mt. Gox (up ~35%) than the rest of the market (up ~7%), like for two reasons:

  1. The general dissociation of Mt. Gox and the rest of the market as outlined below

  2. Anyone looking to capitalize on arbitrage opportunities when withdrawals are reinstated was just given more incentive to buy on Mt. Gox, tightening the cross-exchange spread

Worth noting, since withdrawals were not actually reinstated, selling pressure from arbitrageurs hasn’t yet been realized. Instead, we saw an early bite at the expected market gains as an increased likelihood and shorter timeline to withdrawal reinstatement is priced in.

Original

The last week has been a tumultuous period for digital currency markets, driving prices on the industry’s oldest exchange into a tailspin. While volatility is nothing new for bitcoin, a drastic divergence from historic norms has arisen: Mt. Gox has largely dissociated from the rest of the market, offering insight into the market’s perception of risk in dealing with the company.

price drop and differential

Since Mt. Gox suspended fiat withdrawals last summer the market has come to terms with the 10%+ premium paid for bitcoin on that exchange relative to others. Customers being unable to withdraw fiat drove a technical bid for bitcoin, since withdrawing bitcoin was the only way to get money out of the exchange for most people over the last seven months.

Last week the company also suspended bitcoin withdrawals, pointing to underlying protocol issues as the driver for the issue. The result has been not only the immediate disintegration of the cross-exchange spread, but also a quantifiable dissociation with the rest of the market. Fears that transaction malleability led to duplicate withdrawals have stoked concerns of solvency issues at the exchange, making the risk associated with the exchange itself increasingly weigh on price.

Price Dissociation

Historically, Mt. Gox has moved in tandem with the other exchanges, even if at a premium. From April 2013 through mid-January 2014, prices at Mt. Gox maintained a 0.99 correlation with prices at Bitstamp. Since the announcement on February 7 that bitcoin withdrawals were officially suspended, that correlation has fallen towards 0.45.

historical correlation recent correlation

From an external perspective the market likely appears chaotic, but this dissociation may be actually be a positive sign. Since bitcoin itself is a fully fungible asset, the increasing gap in prices across exchanges is primarily a quantification of the counterparty risk of having money tied to Mt. Gox.

At first it seems odd that the price of bitcoin would drop so dramatically at Mt. Gox relative to the rest of the market if there’s no way to withdraw funds of any kind from them. Why bother selling if you can’t get the cash out?

One possible explanation for this is that more than zero people are able to withdraw funds, be it for an extra fee or to an unaffected banking jurisdiction. If that cohort values protection against losing all of their funds in the case of Mt. Gox being insolvent as greater than the haircut they’re taking the bitcoin price, they would be incentivized to sell their coin and withdraw cash.

There’s also the consideration that in a liquidation scenario fiat could be easier to recover since there is greater precedence and regulation for fiat recovery, not to mention those funds are likely stored at a third party bank with sufficient records and security. It’s possible much of the selling lately reflects traders positioning themselves for such a scenario.

Looking Ahead

Perhaps more important is what could happen when the situation is resolved in either direction. In the case that Mt. Gox reinstates bitcoin withdrawals, it would theoretically be a positive for the market since it would restore some semblance of stability at a major exchange. Unfortunately price action may not be quite as straightforward.

At the time this piece was written, Mt. Gox was trading at a 50% discount to Bitstamp. Should withdrawals be reinstated, traders would immediately look to take advantage of that arbitrage. The cross-exchange spread should tighten dramatically, but not before placing heavy selling pressure on healthy exchanges as traders look to capture the arbitrage value.

Knowing that, one might wonder why anyone would buy on Bitstamp or BTC-e after an announcement of reinstated bitcoin withdrawals from Mt. Gox. Anyone doing so would just be eating the arb gained by those selling coin from Gox. Though it would seem crazy to do so at first, the positive impact on price from an exchange reinstated bitcoin withdrawals has already been tested this week. When Bitstamp did so on Feb 14, prices spiked more than $100 across exchanges. As we’ve shown above, the impact from Gox doing the same is likely to be relatively muted given the price dissociation since then, but almost certainly will be more than zero.

withdrawal reinstatement

So, while the market is sure to see an influx of bitcoin from Mt. Gox customers ready to sell below market, getting an order filled to take advantage of the expected price gain from the news likely means outbidding others. As such, it wouldn’t be surprising to see any realized selling pressure be short-lived ahead of a recovery and subsequent gain, especially when considering that sellers from Gox will be distributed across a number of exchanges, thinning out their impact.

Despite widespread speculation, the case of a full-out Mt. Gox collapse seems unlikely in the immediate future. If there truly is an insolvency issue, it’s in the company’s interest to simply extend the withdrawal hiatus as long as possible. Since the announcement on Feb 7, Gox has seen approximately $200M in trading volume. Even at a conservative 25bp on either side, that’s $1M in revenue over the last week.

XBT/USD only, assumes 25bp average fee

XBT/USD only, assumes 25bp average fee

Whatever the outcome, the market is increasingly quarantining the issues at Gox and lessening the impact events there have on the rest of the market. This creates a greater consolidation of importance on the other existing exchanges for the time being, but with new companies entering the market every day that dissociation is almost certainly a long-term positive for bitcoin.

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