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Trading volume and liquidity provision in cryptocurrency markets

Author

Listed:
  • Bianchi, Daniele

    (Queen Mary University of London)

  • Babiak, Mykola

    (Lancaster University Management School)

  • Dickerson, Alexander

    (Warwick Business School, University of Warwick)

Abstract

We provide empirical evidence within the context of cryptocurrency markets that the returns from liq uidity provision, proxied by the returns of a short-term reversal strategy, are primarily concentrated in trading pairs with lower levels of market activity. Empirically, we focus on a moderately large cross section of cryptocurrency pairs traded against the U.S. Dollar from March 1, 2017 to March 1, 2022 on multiple centralised exchanges. Our findings suggest that expected returns from liquidity provision are amplified in smaller, more volatile, and less liquid cryptocurrency pairs where fear of adverse selection might be higher. A panel regression analysis confirms that the interaction between lagged returns and trading volume contains significant predictive information for the dynamics of cryptocurrency returns. This is consistent with theories that highlight the role of inventory risk and adverse selection for liquidity provision.

Suggested Citation

  • Bianchi, Daniele & Babiak, Mykola & Dickerson, Alexander, 2022. "Trading volume and liquidity provision in cryptocurrency markets," Working Paper Series 413, Sveriges Riksbank (Central Bank of Sweden).
    • Handle: RePEc:hhs:rbnkwp:0413
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    Cited by:

    1. Walid Mensi & Mariya Gubareva & Hee-Un Ko & Xuan Vinh Vo & Sang Hoon Kang, 2023. "Tail spillover effects between cryptocurrencies and uncertainty in the gold, oil, and stock markets," Financial Innovation, Springer;Southwestern University of Finance and Economics, vol. 9(1), pages 1-27, December.
    2. Christian Fieberg & Gerrit Liedtke & Daniel Metko & Adam Zaremba, 2023. "Cryptocurrency factor momentum," Quantitative Finance, Taylor & Francis Journals, vol. 23(12), pages 1853-1869, November.
    3. Di Casola, Paola & Habib, Maurizio Michael & Tercero-Lucas, David, 2023. "Global and local drivers of Bitcoin trading vis-à-vis fiat currencies," Working Paper Series 2868, European Central Bank.
    4. Cakici, Nusret & Shahzad, Syed Jawad Hussain & Będowska-Sójka, Barbara & Zaremba, Adam, 2024. "Machine learning and the cross-section of cryptocurrency returns," International Review of Financial Analysis, Elsevier, vol. 94(C).
    5. Crépellière, Tommy & Pelster, Matthias & Zeisberger, Stefan, 2023. "Arbitrage in the market for cryptocurrencies," Journal of Financial Markets, Elsevier, vol. 64(C).
    6. Fieberg, Christian & Liedtke, Gerrit & Zaremba, Adam, 2024. "Cryptocurrency anomalies and economic constraints," International Review of Financial Analysis, Elsevier, vol. 94(C).
    7. Fieberg, Christian & Günther, Steffen & Poddig, Thorsten & Zaremba, Adam, 2024. "Non-standard errors in the cryptocurrency world," International Review of Financial Analysis, Elsevier, vol. 92(C).

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    More about this item

    Keywords

    Liquidity provision; short-term reversal; trading volume; empirical asset pricing; adverse selection.;
    All these keywords.

    JEL classification:

    • C58 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Financial Econometrics
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G17 - Financial Economics - - General Financial Markets - - - Financial Forecasting and Simulation

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