Coinbase keeps making news with their statements bragging of increasing capacity by 1000%, with more increases by next month and even more towards the end of the year. Of course, this news is posted on almost all of the popular crypto related forums where readers upvote the headline and mistakenly believe this must mean thousands of new accounts are going to be opened. To the moon the say!
But not so fast, there is a smaller story that seems to get missed but it is much more important and it is the real reason that Coinbase is adding that new capacity. The reason is to allow the controversial practice of high frequency trading.
All of the improvements that Coinbase is making are aimed at catering to high frequency traders. Traders who use computers and algorithms to make ultra fast trades, undermining true market behavior. Coinbase has already stated they are making these improvements to provide “low latency” trading times. This is code language meaning their platform will cater to high frequency traders at the expense of slower moving retail traders.
Not to mention, this also brings up the issue of co-location. In this practice, privileged traders will actually be trading directly as part of the Coinbase platform. They will literally be a part of the platform, not just accessing it. This clearly sets up a privileged class of investor that has an obvious advantage over others who are simply accessing the platform.
One of the reasons for this co-location access is because speed is so important in high frequency trading that even being a few miles away is enough for one party to lose out on profits to another party who is located closer and can get their orders in only a millisecond sooner. Clearly, in this scenario, a retail trader can only hope to pick the side of the winning computer algorithm, as that is what will make the market, not traditional market behavior or technical analysis.
The problem with introducing high frequency trading to crypto markets, other than how it bullies retail investors and makes for an unfair trading platform, is that it will make crypto even more volatile. High frequency trading (HFT) increases the chances of flash crashes. For example, in 2010 the Dow dropped 10% in just 20 minutes and people were baffled as to why. A later investigation showed the flash crash was caused by HFT that all reacted to a large sell order. With no human oversight, the trading algorithms went off on their own and caused the crash.
But the thing is, the Dow and other markets have circuit breakers to prevent these huge sell offs to keep going. But crypto has no such thing, exchanges can let a price drop all the way to zero, as happened with Ethereum in 2017 on Coinbase. Many sell orders were executed when the price dipped to 10 cents all the way from $300 in a flash crash, but only briefly. But it was enough to liquidate millions in positions by retail investors who had set sell orders to protect their investments.
Another issue with HFT is that it promotes false liquidity. Crypto markets already have a serious liquidity problem. With HFT, because the trading happens so fast, often in milliseconds, that means the liquidity provided by HTF can disappear in less than a second.
So don’t get too excited about Coinbase adding all this new capacity. While the masses imagine it means they expect new sign ups by retail investors, the real reason is to create a very unfair trading environment where algorithms operate in locked and secure rooms to make the market while the average retail investor scratches their head wondering what just happened.