Distributed ledger technologies rely on consensus protocols confronting traders with random waiting times until the transfer of ownership is accomplished. This time-consuming settlement process exposes arbitrageurs to price risk and imposes limits to arbitrage. We derive theoretical arbitrage boundaries under general assumptions and show that they increase with expected latency, latency uncertainty, spot volatility , and risk aversion. Using high-frequency data from the Bitcoin network , we estimate arbitrage boundaries due to settlement latency of on average 124 basis points, covering 88 percent of the observed cross-exchange price differences. Settlement through decentralized systems thus induces non-trivial frictions affecting market efficiency and price formation .
Distributed ledger technologies replace trusted clearing counterparties and security depositories with time-consuming consensus protocols to record the transfer of ownership . This settlement latency exposes cross-market arbitrageurs to price risk . We theoretically derive arbitrage bounds that increase with expected latency, latency uncertainty, volatility and risk aversion. Using Bitcoin orderbook and network data , we estimate arbitrage bounds of on average 121 basis points, explaining 91\% of the observed cross-market price differences. Consistent with our theory, periods of high latency-implied price risk exhibit large price differences, while asset flows chase arbitrage opportunities. Blockchain-based settlement thus introduces a non-trivial friction that impedes arbitrage activity .
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rely on consensus protocols confronting traders with random waiting times until
replace trusted clearing counterparties and security depositories with time-consuming consensus protocols to record
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is accomplished. This time-consuming settlement process exposes
. This settlement latency exposes cross-market
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and imposes limits to arbitrage. We derive theoretical arbitrage boundaries under general assumptions and show that they
. We theoretically derive arbitrage bounds that
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spot volatility ,
volatility
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high-frequency data from the Bitcoin network
Bitcoin orderbook and network data
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boundaries due to settlement latency
bounds
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124
121
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covering 88 percent
explaining 91\%
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cross-exchange
cross-market
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Settlement through decentralized systems thus induces
Consistent with our theory, periods of high latency-implied price risk exhibit large price differences, while asset flows chase arbitrage opportunities. Blockchain-based settlement thus introduces a
R
frictions affecting market efficiency and price formation
friction that impedes arbitrage activity