Why the Ethereum crash is GREAT!
Recently in the news there have been many different articles discussing the flash crash of the Ethereum Token on GDAX. I think that it is EXTREMELY important to differentiate between a flash crash for the entire world supply of a token or currency and the full utilization of limited liquidity on a centralized exchange.
What these articles have failed to emphasize or even point out at all is that it was NOT the entire world price of Ethereum that briefly crashed, but rather there was one isolated environment on a centralized exchange where the demand to buy or sell a single product exceeded the available liquidity that was close to global market prices.
Just because food or fuel could become extremely expensive during a natural disaster in a remote region, it does not mean that the entire world supply is experiencing the same price conditions as that isolated environment. Adversely there are locations where products are so abundant and in so little demand that no reasonable or worthwhile price for the producers or holders of a product can be established. Currently we are seeing on a regular basis that digital currencies are trading at a premium in Korea, Japan, and India. This is occurring for the same reasons mentioned above. Demand is exceeding the available limited supply. Just because Bitcoin is trading with a $1000 premium over the world market average at a specific location or exchange, it does not mean that the global price has reached that premium. The existing inefficiencies and slow block times make arbitrage possible with such conditions.
What happened on GDAX is not a new phenomenon for any centralized exchange or trading environment. It has been happening for centuries and will continue to happen forever as long as centralized exchanges and market places exist. There are many efficiencies and conveniences when using a centralized market environment. It is because of these efficiencies and conveniences that they have been used for centuries. When looking at this model it is easy to find thousands of instances when demand exceeded supply and the price of a product or service almost instantly became extremely deflated or inflated but quickly returned to normalization. If a person has a smaller quantity of a product such as 0.5 BTC it would be very easy to find a buyer willing to pay market or very close to market prices for the Bitcoin using the current online resources such as localbitcoins.com. However if a seller has 10000 BTC that they want to sell instantly it is possible they will not be able to find enough buyers at market prices between several of the largest exchanges. While most of the existing non-blockchain exchanges have rules to prevent “sweeping the book” or to prevent unlimited short selling, this type of rule is almost impossible in a global market without central authority unless pre-programmed into the code of a token or smart contract.
If a person was trading an FX or CFD product and a huge buy or sell order was placed on the exchange the trades would not be allowed to go through due to automated rules on the exchange. If they did go through accidentally or beyond what is considered to be close to the normal threshold then the trades would be “busted” meaning they would be invalidated and they would be made as if they did not happen. Alternatively, the trades would have the entry or exit price adjusted to reflect prices closer to the market average at this time.
Having been actively involved in the brokerage industry for more than 15 years, I know that this situation is actually much more common than most clients realize. My experience has been that the majority of major financial institutions have some level of this occurring on a daily basis. The difference is that when brokers control the database which is not public it is possible to go back and “FIX” these transactions. Most of the time the price movements and differences being “FIXED” are not so extreme, but such situations do happen in the CFD industry on a regular basis but they are almost always quickly resolved before anyone but the dealing desk team and maybe a few clients know the issue even occurred. The charts and prices are put back to what they “should have been” and life goes on with most people never thinking anything more of this. However with an open Blockchain it is not possible to go back and “FIX” the prices after such an event.
With this said, the reason I think it is GREAT that the Ethereum crash happened is because it will help people wake up and see that the centralized exchange model with limited liquidity while convenient can be just as or even more dangerous with a Blockchain setup that can not be “FIXED”. More importantly I hope that this will further drive both users and exchanges to begin utilizing Peer2Peer matching engines. Less centralized exchanges such as Bitshares, Lykke, and other similar exchanges have proven that such matching can be done while also maintaining a much higher level of security for the end clients.
Even more importantly I hope that this will help drive the Blockchain community to further realize the importance of increasing the scalability of the networks through the implementation of the Lightning network on Bitcoin and Raiden Network on Ethereum. The implementation of these protocols will go a long way to helping improve not just the speed and scalability but also stability of prices by making possible better price discovery.