Decentralized finance (DeFi) is the undisputed driver of the crypto world’s latest growth spurt. Decentralized exchanges (DEXs) and liquidity pools experienced their fastest surge ever in the most recent quarter.
The problem is, serious questions around price integrity have also arisen during the recent growth spurt - including in this corner of the market - as manipulation attacks and other issues reveal poor controls and weak data validation.
- bZx had to take down its Ether-based margin lending and trading protocol, after around $1 million was stolen in two sophisticated attacks targeting vulnerabilities linked to the use of a single pricing oracle
- Synthetix, a DeFi platform for trading tokenized ‘real-world’ assets, was hit with price manipulation attacks that led to the loss of $2.5 million for holders of its main token, SNX
- AMPL failed to live up to its stablecoin ambitions when it exploded to $13,000 from around $1.80 in just a few minutes on the FTX exchange. The venue’s CEO cited “an error in the spot AMPL books for a few users”
- Deribit had to reimburse over $1.3 million of losses clients suffered in a ‘flash crash’ on its options and futures platform from an “index calculation data issue”
‘Flash Crash’: a chart reveals the pricing incident on Deribit’s trading platform on 31st October 2019, at around 21:00 UTCSource: Deribit
These incidents reflect one of the crypto world’s greatest (and oldest) conundrums: how to establish the price of an asset, like Bitcoin, at any given time. For one thing, there may be around 500 entities operating as crypto exchanges world-wide. As the number of DEXs also increases, the proliferation of trading venues can only accelerate. This expansion poses an obvious dilemma: it fails to address the lack of established and guaranteed pricing standards for digital assets. In fact, as the crypto boom continues, it follows that the problem is getting worse. The key implications of this lack of standards are outlined below.
- In crypto markets, on any given trading day, there’s a substantial price arbitrage. In June, consultancy Coygo estimated a BTC/USD spread of 0.2%-2.5% between key exchanges, a boon for professional speculators, but damaging for just about every other type of market participant
- As we’ve seen already, margin lending on crypto collateral can fail all sorts of risk management and consumer tests without real-time valuations beyond dispute
- More fundamentally, what about taxation? Difficulties in determining capital gains unambiguously are a key reason why certain investors eschew cryptocurrencies
- For traditional financial service providers, out of synch prices make it impossible to conduct critical functions. Asset managers attempting to value collateral are trying to hit a moving target. ETF sponsors aiming to calculate NAV are shooting in the dark
For the crypto sphere as a whole, the overriding impact is undermined confidence. And if confidence is weakened among existing users, it won’t be inspired among late adopters whose participation is crucial for crypto growth to continue.
Solutions that promote price integrity are the obvious remedy. The question is, how can crypto companies secure the most advanced price intelligence?
BlockFi, one of the fastest-growing DeFi leaders, has discovered a highly evolved answer. BlockFi’s platform enables crypto holders to earn interest on their token assets. It also offers loans backed by clients’ crypto collateral. Recognizing its critical need for rock-solid price verification and regulatory adherence, BlockFi recently adopted the crypto pricing framework created by CF Benchmarks.
CF Benchmarks’ pricing methodology includes parameters to deal with erroneous prices, problematic exchange book issues, calculation failures and more, consequently achieving robust, verifiably time-accurate pricing. Here’s an outline of some of the key parameters:
- Prices are calculated from order book data, as opposed to trade data – this fosters the highest possible frequency of price data
- Divergence between mid-prices and the mid-price volume curve is strictly controlled – this minimizes questionable price action of all kinds
- Weight-related and other probabilistic calculations are included in the model – these ensure CF Benchmarks’ prices remain aligned with those of its carefully selected contributing exchanges
The robustness of CF Benchmarks’ methodology has been demonstrated by the CME Group’s adoption of the methodology for its cash-settled Bitcoin contract. Now, BlockFi has established a lead in its own industry by opting for CF Benchmarks’ methodology as well. With the realm of decentralized, distributed finance likely to continue evolving at a rapid pace—with attendant risks—BlockFi’s decision is set to be vindicated as ever more astute and far-sighted.