Strategies for reducing crytocurrency’s trading friction (that don’t work that well)


Disclaimer - If you haven't read my disclaimer yet, make sure you do so here. TL;DR version - Buyer beware, I am not an expert, I am fumbling my way through this like the rest of you.

Also, I hold a little bit of Bitcoin, Ethereum, and Cardano.


So, over the past couple of weeks I've been doing a lot of research into cryptocurrency. I've spotted a few more I'd like to speculate on, identified why people complain about (it's slow to verify), different algorithms for verification (Proof-of-work vs. Proof-of-stake), and tried-but-failed to understand new twists on blockchain (side chains).

However, I want to come back to logistics and talk about cryptocurrency's liquidity problem and how to minimize it.

There are four main sources of friction that I see when it comes to trading:

  1. Trading fees, which I'll talk about in this post
    .
  2. Capital gains taxes, which threatens to be a monstrous problem, which I won't talk about in this post (or possibly ever because it's so complicated and I am not qualified to talk about) [1]
    .
  3. Slippage, which is the different between the price you place an order at, and the price your order is filled
    .
  4. The bid/ask spread; this is more of an issue when buying stocks where if a stock is trading at $4/share, you would buy at the Ask price which might be $4.02, and sell at the Bid price, which might be $3.98. That's a spread of 4 cents per share, so even if the price of $4 never changed, buying and then immediately selling would still result in a net loss (ignoring trading fees and possible slippage).

If you're going to trade, you must reduce friction because it will eat you alive.

I use Coinbase to buy Bitcoin and Ethereum, and then if I want to buy an altcoin, I have to send Bitcoin or Ethereum to a second exchange and then convert it into that altcoin. This is a multi-step process and it's a pain compared to trading traditional securities.

Through my regular brokerage:

  1. I transfer money into my brokerage and it's there the same day, I can usually trade with it right away (or within a minute or two)
    .
  2. I search for the stock, bond, or ETF I want to buy, and then I buy it. It's deposited into my account within seconds. I am charged a fee of $7.

From start to finish, this would take me a few minutes with minimal clicks.

For buying cryptocurrency - specifically an altcoin:

1. I can pick multiple methods for purchasing through Coinbase - either by hooking up to my bank account directly, or by hooking up a debit/credit card. Both methods... are not great.

a) If I choose my bank account, the trading fee earlier today was $14, twice the fee of buying stocks. This deducts the money from my account, less the trading fee, and then purchases the equivalent amount of Bitcoin or Ethereum. However, I'm informed that because of the amount of time it takes for the bank transaction to clear, this will take 11 days. 11 days! Are. You. Kidding. Me.

This is going to introduce a great deal of slippage. 11 days in cryptocurrency-land is like 12 months in stocks/bonds/ETFs-land with regard to price stability.

My trading costs are double and the slippage is (potentially) gigantic. But, at least the price I bought my Bitcoin or Ethereum is locked in today, I don't have to wait for the transaction to clear before acquiring them.

b) If I choose my debit/credit account, the transaction is instant and I'll get my Bitcoin or Ethereum right then and there. But, the trading fee is $38 [2], almost three times the cost of doing it by bank account.

Three times the trading fee! Are. You. Kidding. Me.

2. Next, to buy the alt-coin, I have to send the Bitcoin or Ethereum to my second exchange. There's a fee for this, I think it's a flat fee of the cryptocurrency I am trading (or maybe part of the USD... I forget).

I send it over and it takes somewhere between 15 and 30 minutes to transfer over.

3. Finally, I head over to the second exchange and I convert the Ethereum or Bitcoin to the altcoin. There's a trading fee for that, too.

Start to finish, the I've been hit with three trading fees, and it takes either 7-10 days (option 1a) or 30-40 minutes (option 1b).

As fascinated as I am with cryptocurrency, that end-to-end buying experience sucks compared to buying traditional securities. (Oh, yeah, one more thing - I accidentally clicked "bank account transfer" earlier today to buy some cryptocurrency with the express purpose of buying an altcoin, which I wanted to do today. I can't cancel this trade in progress to do the faster one, and I won't get it until 11 days from now. You might say "So go back and do the instant one." But I can't! I can't pay that 3x fee, I just can't do it...).

Since I need to minimize friction, the only way to do it is to plan in advance. I have to buy some Ethereum or Bitcoin to always have on hand in my Coinbase account on the foreknowledge that I will want to exchange it to another altcoin 7-10+ days from now. Then, while I am sitting around waiting for the transaction to clear, do all my research and pick the ones I am planning to acquire. Then, the day the transaction clears, do the transfer to exchange to an altcoin.

In other words, always keep some funds in hand to give you some flexibility. This helps reduce trading fees.

But it does it at the risk of introducing serious slippage, and also potentially hitting you with taxes.

First, re: slippage, altcoins bounce around a lot. So, if you buy $1000 USD of Ethereum or Bitcoin on Day 1 which has an equivalent price of $1000 USD for the altcoin, on day 10 that same amount of Ethereum may only be able to purchase the equivalent of $900 or $800 of the altcoin due to its appreciation. It could also work the other way. So, there's a lot of instability and unpredictability if you're using this particular strategy.

Second, re: taxes, whenever you transfer any cryptocurrency, that's a taxable event. You buy $1000 worth of Ethereum on Day 1, and on Day 10 you exchange it to an altcoin. Suppose that your $1000 of Ethereum is now worth $1100; the way I understand the IRS tax code is you now have a capital gain of $1100-$1000 = $100 that you must track so you can pay taxes on it. If you're in the 25% tax bracket, it's like you are now buying $1075 worth of the altcoin. Of course, you've bought $1100 USD of the altcoin, but even if you never buy or sell anything for the rest of the year, you'll have a tax liability of $100 which will be treated as a short-term capital gain.

And you're responsible for tracking it all. Good luck!

This is way worse than trading stocks; whenever you sell a stock because you want to buy something else, you have to realize a capital gains similar to the above (ignoring FIFO, LIFO, or choose-your-stocks-to-sell). But the big difference is that you can convert US dollars to any stock, bond, or ETF whereas with the majority of cryptocurrencies force you to convert them from another cryptocurrency first and realize a taxable event. It's not like that buying stocks or bonds.

So no matter what strategy you use, the end-to-end experience sucks.

As a result, because of the risks involved in cryptocurrency speculation, they had better have outsized returns. But of course, the true value in cryptocurrency is not in speculation, but in driving value and using blockchain to solve problems that either couldn't be solved without it, or are much better solved with it.

That's much where I'd prefer to be.


[1] Yes, I realize that after saying I wouldn't talk about taxes, I ended up talking about taxes. So there's no need to bring that up.

[2] Just think about what this means for a second. If you are a small-time speculator in both stocks/bonds/ETFs, and also in cryptocurrencies, a $1000 purchase has a fee of 0.7% for the stock vs. 3.8% for the cryptocurrency. If there's anything I've learned about investing over the past 15 years, it's "Minimize fees!" If you had a mutual fund with a fee of 3.8%, it'd be one of the highest in the industry; only hedge funds can get away with charging that much.

Comments (0)

Skip to main content