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How Artificial Intelligence will revolutionize wealth management

by Michal Rozanski, CEO at Empirica

Most wealth managers are in deep denial about robo advice. They say they need human interaction in order to understand the nuances of financial lives of their customers. And their clients value the human touch. They’re wrong. Soon robo advice will be much more efficient than human advice ever was.

In this post, we will share the results of our analysis on the most important areas where the application of machine learning will have the greatest impact in taking wealth management to the next level.

What Artificial Intelligence is and why you should care

 “Computers can only do what they are programmed to do.” Let us explain this is huge misconception, which was only valid because of limited processing power and memory capacity of computers. Most advanced programs which mimic specialized intelligences, known as expert systems, were indeed programmed around a set of rules based on the knowledge of specialists within the problem’s domain. There was no real intelligence there, only programmed rules. But there is another way to program computers, which makes them work more similarly to the functions of the human brain. It is based on showing the program examples of how certain problems can be solved and what results are expected. This way computers equipped with enough processing power, memory and storage are able to recognize objects in photographs, drive autonomous cars, recognize speech, or analyse any form of information which exhibits patterns.

 

We are entering the age where humans are outperformed by machines in activities related with reasoning based on the analysis of large amounts of information. Because of that finance and wealth management will be profoundly changed during the years to come.

 

Real advice – combining plans with execution

 A great area for improvement in finance management is the combination of long term wealth building with the current financial situation of the customer as reflected by his bank account. For robo-advisors, an integration with bank API opens the door to an ocean of data which, after analysis, can dramatically improve the accuracy of advice provided to the customer.

By applying a machine learning capabilities to a customer’s monthly income and expenses data, wealth managers will gain a unique opportunity to combine two perspectives – the long term financial goals of their customers and their current spending patterns. Additionally, there is the potential of tax, mortgage, loans or credit card costs optimization, as well as using information on spending history to predict future expenditures.

By integrating data from social media, wealth management systems could detect major changes in one’s life situation, job, location, marital status or remuneration. This would allow for automated real time adjustments in investment strategies of on the finest level, which human advisors are simply unable to deliver.

New powerful tools in the wealth manager’s arsenal

Hedge funds that are basing their strategies on AI have provided better results over the last five years than the average (source Eurekahedge). What is interesting is that the gap between AI and other strategies has been growing wider over the last two years, as advancements in machine learning accelerated.

The main applications of machine learning techniques in wealth management, can be categorized following cases:

  •       Making predictions on real-time information from sources such as market data, financial reports, news in different languages, and social media
  •       Analysis of historical financial data of companies to predict the company’s cash flow and important financial indicators based on the past performance of similar companies
  •       Analysis of management’s public statements and activity on social networks in order   to track the integrity of their past words, actions and results
  •       Help in accurate portfolio diversification by looking for uncorrelated instruments which match requirements of the risk profile
  •       Generation of investment strategies parametrized by goals such as expected risk profiles, asset categories, and timespan, resulting in sets of predictive models which may be applied in order to fulfill the assumptions

 To give an example of machine learning accuracy, the algorithms for sentiment analysis and document classification are already on acceptable levels, well above 90%.

Automated execution

When it comes to the execution of the actual orders behind portfolio allocation and rebalancing strategies, many robo-advisors are automating these processes passing generated orders to brokerage systems. The next step would be autonomous execution algorithms, that take under consideration the changing market situation and learn from incoming data, allowing for increased investment efficiency and reduced costs.

Machine learning can be applied to quantitative strategies like trend following, pattern recognition, mean reversion, and momentum, as well as the prediction and optimization of statistical arbitrage, and pairs trading. Additionally, there is a possibility to apply machine learning techniques in, already quite sophisticated, execution algorithms that help execute large orders by dividing them to thousands of smaller transactions without influencing the market while adjusting their aggressiveness to the market situation.

What’s interesting is that algorithms could also be trained to make use of rare events, like market crashes and properly react in milliseconds, already knowing the patterns of panic behaviour and shortages of liquidity.

Explaining the markets

In wealth management systems, if portfolio valuations are provided to the customers in real time, then so should explanations of the market situation. Every time the customer logs in to the robo-advisor, she should see all required portfolio information with a summary of market information relevant to the content of her portfolio. This process includes the selection of proper articles or reports concerning companies from the investor portfolio, classification and summarization of negative or positive news, and delivering a brief overview.

Additionally, machine learning algorithms can be used to discover which articles are read by customers and present only those type of articles that were previously opened and read by the customer.

The result will be not only the increase in customer understanding but also, by providing engaging content to investors, the increase in their engagement and commitment to portfolio strategy and wealth management services.

 

Talking with robots

The ability to deliver precise explanations of the market situation in combination with conversational interfaces aided by voice recognition technology will enable robo-advisors to provide financial advice in a natural, conversational way.

Voice recognition is still under development, but it could be the final obstacle on they way to redesigning human-computer interaction. On the other hand, thanks to deep learning, chatbot technology and question answering systems are getting more reliable than ever. KAI, the chatbot platform of Kasisto, who has been trained in millions of investment and trade interactions, already handles 95 % of all customer queries for India’s digibank.

Decreasing customer churn with behavioral analysis

The ability to track all customer actions, analyzing them, finding common patterns in huge amounts of data, making predictions, and offering unique insights for fund managers delivers a powerful business tool not previously available to wealth managers. What if nervousness caused by portfolio results or market situation could be observed in user behaviour within the system?  This information, combined with the results of investments and patterns of behaviour of other investors, can give a wealth manager the possibility to predict customer churn and react in advance.

When speaking with wealth management executives that are using our robo-advisory solutions, they indicate behavioural analysis as one of the most important advancements to their current processes. Customers leave not only when investment results are bad, but also when they are good if there is a fear that the results may not be repeated in the future. Therefore, the timely delivery of advice and explanations of market changes and the current portfolio situation are crucial.

The same model we used to solve the behavioral analysis problem has been proven to predict credit frauds in 93.07% of cases.

Summary

Other areas of applying machine learning in the processes supporting wealth management services could be:  

  •       Security based on fraud detection which actively learns to recognize new threats
  •       Improving sales processes with recommendations of financial products chosen by similar customers
  •       Psychological profiling of customers to better understand their reactions in different investment situations      
  •       Analysis and navigation of tax nuances   
  •       Real estate valuation and advice

 Implementing these AI functions in wealth management systems will be an important step towards the differentiation of the wealth managers on the market. Today’s wealth managers’ tool set will look completely different in five years. Choosing an open and innovative robo-advisory system that tackles these future challenges is crucial. Equally important will be wealth managers’ incorporation of data analytic processes and the use of this data to help their customers.

Artificial intelligence is poised to transform the wealth management industry. This intelligence will be built on modern software platforms that combine data from different sources, process it, and transform it into relevant financial advice. The shift from data gathering systems to predictive ones that help wealth managers to understand the data, has already started. And wealth management is all about understanding the markets and the customers.

 

 

Now Crypto. Lessons learned from over 10 years of developing trading software

By Michal Rozanski, CEO at Empirica.

Reading news about crypto we regularly see the big money inflow to new companies with a lot of potentially breakthrough ideas. But aside from the hype from the business side, there are sophisticated technical projects going on underneath.

And for new cryptocurrency and blockchain ideas to be successful, these projects have to end with the delivery of great software systems that scale and last. Because we have been building these kinds of systems for the financial markets for over 10 years we want to share a bit of our experience.

Read more on how Empirica delivers its trading software development services

“Software is eating the world”. I believe these words by Marc Andreessen. And now the time has come for financial markets, as technology is transforming every corner of the financial sector. Algorithmic trading, which is our speciality, is a great example. Other examples include lending, payments, personal finance, crowdfunding, consumer banking and retail investments. Every part of the finance industry is experiencing rapid changes triggered by companies that propose new services with heavy use of software.

If crypto relies on software, and there is so much money flowing into crypto projects, what should be looked for when making a trading software project for cryptocurrency markets? Our trading software development projects for the capital and crypto markets as well as building our own algorithmic trading platform has taught us a lot. Now we want to share our lessons learned from these projects.

 

  1. The process – be agile.

Agile methodology is the essence of how software projects should be made. Short iterations. Frequent deliveries. Fast and constant feedback from users. Having a working product from early iterations, gives you the best understanding of where you are now, and where you should go.

It doesn’t matter if you outsource the team or build everything in-house; if your team is local or remote. Agile methodologies like Scrum or Kanban will help you build better software, lower the overall risk of the project and will help you show the business value sooner.

 

  1. The team – hire the best.

A few words about productivity in software industry. The citation is from my favourite article by Robert Smallshire ‘Predictive Models of Development Teams and the Systems They Build’ : ‘… we know that on a small 10 000 line code base, the least productive developer will produce about 2000 lines of debugged and working code in a year, the most productive developer will produce about 29 000 lines of code in a year, and the typical (or average) developer will produce about 3200 lines of code in a year. Notice that the distribution is highly skewed toward the low productivity end, and the multiple between the typical and most productive developers corresponds to the fabled 10x programmer.’.

I don’t care what people say about lines of code as a metric of productivity. That’s only used here for illustration.

The skills of the people may not be that important when you are building relatively simple portals with some basic backend functionality. Or mobile apps. But if your business relies on sophisticated software for financial transactions processing, then the technical skills of those who build it make all the difference.

And this is the answer to the unasked question why we in Empirica are hiring only best developers.

We the tech founders tend to forget how important it is to have not only best developers but also the best specialists in the area which we want to market our product. If you are building an algo trading platform, you need quants. If you are building banking omnichannel system, you need bankers. Besides, especially in B2B world, you need someone who will speak to your customers in their language. Otherwise, your sales will suck.

And finally, unless you hire a subcontractor experienced in your industry, your developers will not understand the nuances of your area of finance.

 

  1. The product – outsource or build in-house?

If you are seriously considering building a new team in-house, please read the points about performance and quality, and ask yourself the question – ‘Can I hire people who are able to build systems on required performance and stability levels?’. And these auxiliary questions – can you hire developers who really understand multithreading? Are you able to really check their abilities, hire them, and keep them with you? If yes, then you have a chance. If not, better go outsource.

And when deciding on outsourcing – do not outsource just to any IT company hoping they will take care. Find a company that makes systems similar to what you intend to build. Similar not only from a technical side but also from a business side.

Can outsourcing be made remotely without an unnecessary threat to the project? It depends on a few variables, but yes. Firstly, the skills mentioned above are crucial; not the place where people sleep. Secondly, there are many tools to help you make remote work as smooth as local work. Slack, trello, github, daily standups on Skype. Use it. Thirdly, find a team with proven experience in remote agile projects. And finally – the product owner will be the most important position for you to cover internally.

And one remark about a hidden cost of in-house development, inseparably related to the IT industry – staff turnover costs. Depending on the source of research, turnover rates for software developers are estimated at 25% to even 38%. That means that when constructing your in-house team, every fourth or even every third developer will not be with you in a year from now. Finding a good developer – takes months. Teaching a new developer and getting up to speed – another few months. When deciding on outsourcing, you are also outsourcing the cost and stress of staff turnover.

 

  1. System’s performance.

For many crypto projects, especially those related with trading,  system’s performance is crucial. Not for all, but when it is important, it is really important. If you are building a lending portal, performance isn’t as crucial. Your customers are happy if they get a loan in a few days or weeks, so it doesn’t matter if their application is processed in 2 seconds or in 2 minutes. If you are building an algo trading operations or bitcoin payments processing service, you measure time in milliseconds at best, but maybe even in nanoseconds. And then systems performance becomes a key input to the product map.

95% of developers don’t know how to program with performance in mind, because 95% of software projects don’t require these skills. Skills of thinking where bytes of memory go, when they will be cleaned up, which structure is more efficient for this kind of operation on this type of object. Or the nightmare of IT students – multithreading. I can count on my hands as to how many people I know who truly understand this topic.

 

  1. Stability, quality and level of service.

Trading understood as an exchange of value is all about the trust. And software in crypto usually processes financial transactions in someway.

Technology may change. Access channels may change. You may not have the word ‘bank’ in your company name, but you must have its level of service. No one in the world would allow someone to play with their money. Allowing the risk of technical failure may put you out of business. You don’t want to spare on technology. In the crypto sapce there is no room for error.

You don’t achieve quality by putting 3 testers behind each developer. You achieve quality with processes of product development. And that’s what the next point is about.

 

  1. The DevOps

The core idea behind DevOps is that the team is responsible for all the processes behind the development and continuous integration of the product. And it’s clear that agile processes and good development practices need frequent integrations. Non-functional requirements (stability and performance) need a lot of testing. All of this is an extra burden, requiring frequent builds and a lot of deployments on development and test machines. On top of that there are many functional requirements that need to be fulfilled and once built, kept tested and running.

On many larger projects the team is split into developers, testers, release managers and system administrators working in separate rooms. From a process perspective this is an unnecessary overhead. The good news is that this is more the bank’s way of doing business, rarely the fintech way. This separation of roles creates an artificial border when functionalities are complete from the developers’ point of view and when they are really done – tested, integrated, released, stable, ready for production. By putting all responsibilities in the hands of the project team you can achieve similar reliability and availability, with a faster time to the market. The team also communicates better and can focus its energy on the core business, rather than administration and firefighting.

There is a lot of savings in time and cost in automation. And there are a lot of things that can be automated. Our DevOps processes have matured with our product, and now they are our most precious assets.

 

  1. The technology.

The range of technologies applied for crypto software projects can be as wide as for any other industry. What technology makes best fit for the project depends, well, on the project. Some projects are really simple such as mobile or web application without complicated backend logic behind the system. So here technology will not be a challenge. Generally speaking, crypto projects can be some of the most challenging projects in the world. Here technologies applied can be the difference between success and failure. Need to process 10K transaction per second with a mean latency under 1/10th ms. You will need a proven technology, probably need to resign from standard application servers, and write a lot of stuff from scratch, to control the latency on every level of critical path.

Mobile, web, desktop? This is more of a business decision than technical. Some say the desktop is dead. Not in trading. If you sit whole day in front of the computer and you need to refer to more than one monitor, forget the mobile or web. As for your iPhone? This can be used as an additional channel, when you go to a lunch, to briefly check if the situation is under control.

 

  1. The Culture.

After all these points up till now, you have a talented team, working as a well-oiled mechanism with agile processes, who know what to do and how to do it. Now you need to keep the spirits high through the next months or years of the project.

And it takes more than a cool office, table tennis, Xbox consoles or Friday parties to build the right culture. Culture is about shared values. Culture is about a common story. With our fintech products or services we are often going against big institutions. We are often trying to disrupt the way their business used to work. We are small and want to change the world, going to war with the big and the powerful. Doesn’t it look to you like another variation of David and Goliath story? Don’t smile, this is one of the most effective stories. It unifies people and makes them go in the same direction with the strong feeling of purpose, a mission. This is something many startups in other non fintech branches can’t offer. If you are building the 10th online grocery store in your city, what can you tell your people about the mission?

Read more on how Empirica delivers its crypto software development services

 

Final words

Crypto software projects are usually technologically challenging. But that is just a risk that needs to be properly addressed with the right people and processes or with the right outsourcing partner. You shouldn’t outsource the responsibility of taking care of your customers or finding the right market fit for your product. But technology is something you can usually outsource and even expect significant added value after finding the right technology partner.

At Empirica we have taken part in many challenging crypto projects, so learn our lessons, learn from others, learn your own and share it. This cycle of learning, doing and sharing will help the crypto community build great systems that change the rules of the game in the financial world!

 

 

Independent initiatives that analyze crypto exchanges liquidity and quality

Volume is flawed metric of crypto exchanges liquidity. Because of wash trading practices of many crypto exchanges as well as token issuers, using trading volume as a basis of comparison is misleading.

There are more and more independent initiatives that are taking a closer look at what constitutes a high quality crypto exchange. Three major ones are Blockchain Transparency Institute, CryptoCompare Benchmark and Cointelligence Report. I also take a quick look at the Bitwise report for SEC from March 2019.

 

Read more about our tool for measuring crypto exchange quality – Liquidity Analytics Dashboard

 

Blockchain Transparency Institute

BTI concentrates on analyzing crypto exchanges data feeds to spot wash trading mechanisms and provide the real volume metric which is cleaned out of suspicious activities.

BTI identified 17 of the CoinMarketCap Top 25 crypto exchanges to be over 99% wash traded. This one number alone shows the magnitude of the problem, as well as how volume is a false measure.

According to BTI Report crypto exchanges which are faking their volumes use a variety of different tactics to try and swindle investors. These tactics include buying twitter followers and likes, filling up fake order books, mirror wash trading the largest exchanges with real volume, and trying to disguise their wash trading using various bot settings to not affect price. On many of these exchanges trading high volumes closing the spread would make the volume plummet as the bots had no room to wash trade with themselves. Welcome to the wild wild west of no regulation and surveillance.

BTI finds that “all crypto exchanges combined are currently reporting around $50 Billion in daily volume on CMC. After removing all the wash traded volume via our algorithms the accurate number is around $4-5 Billion. About 88-92% of daily trading volume is fabricated depending on the day. Bitcoin’s daily trading volume is about 92% fabricated, which is in line with the space as a whole when comparing our findings to top data sites reporting wash traded volumes.” 

And further “On our list of the top 40 largest exchanges with actual volume, Bitcoin’s volume is about 65% fabricated. Almost all of this fabricated volume comes from OKEx, Bibox, HitBTC, and Huobi. Of the top 25 tokens by market cap, Tron and Ethereum Classic are the highest wash traded tokens on our list at 85% fake volume each and coming in at #24 and #25 of the most wash traded tokens.”

Top 10 cryptocurrency exchanges according to real (not wash traded) volume by BTI

  1. Binance 
  2. Kucoin
  3. Liquid
  4. Huobi
  5. Coinbase
  6. OKEx
  7. Bitfinex
  8. Upbit
  9. Kraken
  10. Bitstamp

CryptoCompare

CryptoCompare’s Exchange Ranking methodology utilises a combination of 34 qualitative and quantitative metrics to assign a grade to over 100 active crypto exchanges. Metrics were categorised into several buckets ensuring that no one metric overly influences the overall exchange ranking. Each crypto exchange grade is derived from a broad due diligence check using qualitative data, followed by a market quality analysis that uses a combination of order book and transactional data.

Due diligence check comprises of 6 main categories that attempt to qualitatively rate each exchange on the basis of:

  • Geography
  • Legal and regulatory metrics
  • Calibre of investment
  • Team and company quality
  • Quality of data provision
  • Trade surveillance

Although at Empirica we believe in numbers, I like the qualitative approach, as it’s also possible to prove a correlation of metric like number of employees and business size of the exchange, therefore proving this way it’s quality. 

Another important factor is Market Quality. Crypto compare measures the market quality of each exchange using a combination of 5 metrics (derived from trade and order book data) that aim to measure the:

  • Cost to trade, 
  • Liquidity, 
  • Market stability, 
  • Behaviour towards sentiment
  • “Natural” trading behaviour

Exchanges were rated based on a combination of 9 of the most liquid BTC and ETH markets.

It’s worth taking a closer look how CryptoCompare report approaches Spread and Liquidity metrics:

“Generally, those exchanges which offer incentives to provide liquidity through either low or negative maker fees will achieve the tightest spreads. Due to the spread being calculated using the best bid and offer, it is misleading to use it as a sole gauge of liquidity and therefore as the market cost to trade; it must be used in conjunction with a depth

measurement to find the likely transaction price for any given size of transaction.”

 

Good point. And liquidity:

“Market depth is the total volume of orders in the order book. It provides an idea of how much it is possible to trade on crypto exchange, and how much the price is likely to move if large amounts are traded. An exchange with greater average depth is likely to be more stable (i.e flash crashes are much less likely) and allows trading of greater amounts at better prices.

We consider the depth up to 1% either side of the mid price. 

Depth = E(depthUp+depthDown)/2

Where depthUp is the total volume that would be required to move the price by 1% upwards from the mid price, and

depthDown is the total volume that would be required to move the price by 1% downwards from the mid price.”

 

Top 10 crypto exchanges according CryptoCompare quality benchmark:

  1. Coinbase 
  2. Poloniex 
  3. Bitstamp 
  4. bitFlyer 
  5. Liquid
  6.  itBit 
  7. Kraken 
  8. Binance 
  9. Gemini 
  10. Bithumb 

 

Cointelligence Rating System

Cointelligence is the most qualitative rating of crypto exchanges from the above. The methodology of the team was to manaully open accounts on all analyzed crypto exchanges and check from the user perspective the core aspects of beeing an exchange customer. The aspects cover:

Usability – covers KYC process, the quality of exchange website, extent of features and how easy it is to get a human answer from support staff. 

Performance – functionalities and historical robustness of exchange matching engine, fees height, trading instruments like futures contracts and margin trading.

Team – analysis of the available information about management team behind the crypto exchange, especially business and technical experience of C-level staff, including person responsible for exchange’s security

Risk – information on past hacks, insurance status, account security layers but also regulatory status of cryptocurrency exchange. Based on the geographical location of the exchange headquarters and registration any potential run-ins with the local law or any sign of authorities involvement.

 

This way Contelligence analyzed 85 crypto exchanges, but only 15 is rated with good quality mark, lead by Liquid and Gemini. 

Top 10 cryptocurrency exchanges by Cointelligence by qualitative criteria 

  1. Liquid (Quoine)
  2. Gemini
  3. Binance
  4. Bitstamp
  5. Gibraltar Blockchain Exchange
  6. OKEx
  7. Bittrex
  8. itBit
  9. Kraken
  10. ABCC

Bitwise report for SEC

Bitwise analysis is based on detecting wash trading patterns in public marked data published by crypto exchanges. Out of 81 exchanges they have analyzed in March 2019 only 10 were identified as be free of wash trading practices. These exchanges are:

  1. Binance
  2. Bitfinex
  3. Kraken
  4. Bitstamp
  5. Coinbase
  6. bitFlyer
  7. Gemini
  8. itBit
  9. Bitrex
  10. Poloniex

Bitwise identified that only 4,5% (about $275M daily) of officially reported volume (eg by the public sources like coinmarketcap) is the actual volume. The rest is wash traded.

The Bitcoin market is more orderly and efficient than is commonly understood. The 10 exchanges trade as a uniform, highly connected market. They form a singular price. Average deviations from the aggregate price for the ten exchanges is well within the expected arbitrage band when you account for exchange-level fees (~30 basis points), volatility and hedging costs. Arbitrage is operating well. Sustained deviations (defined as deviations >1% that last more than 100 seconds) appear as single white lines on the graph below. The graph demonstrates that the ten exchanges trade at a single unified price.

So although the message about the amount of wash traded volume is alarming, the report shows that the real crypto market is quite concentrated, ordered, efficient and well performing. The rest is just noise.

 

 

Read more about our tool for measuring crypto exchange quality – Liquidity Analytics Dashboard

 

 

Algorithmic crypto trading: market specifics and strategy development

By Marek Koza, Product Owner of Empirica’s Algo Platform

Among trading professionals, interest in crypto-currency trading is steadily growing. At Empirica we see it by an increasing number of requests from trading companies, commonly associated with traditional markets, seeking algorithmic solutions for cryptocurrency trading. However, new crypto markets suffer from old and well-known problems. In this article, I try to indicate the main differences between traditional and crypto markets and take a closer look at a few algorithmic strategies that are currently effective in the crypto space. Differences between crypto and traditional markets constitute an interesting and deep subject in itself which is evolving quickly as
the pace of change in crypto is also quite fast. But here I only want to focus on algorithmic trading perspectives.

 

Read more about our tool for market making strategies for crypto exchanges  – Liquidity Engine

 

LEGISLATION

First, there is a lack of regulations in terms of algorithmic usage. Creating DMA algorithms on traditional markets requires a great deal of additional work to meet reporting, measure standards as well as limitations rules provided by regulators (e.g., EU MiFIDII or US RegAT). In most countries crypto exchanges have yet to be covered by legal restrictions. Nevertheless, exchanges provide their own internal rules and technical limitations which, in a significant way, restricts the possibility of algorithmic use, especially in HFT field. This is crucial for market-making activities which now requires separated deals with trading venues.

 

DERIVATIVES

As for market-making, we should notice an almost non-existent derivatives market in the cryptoworld. Even if a few exchanges offer futures and options, they only apply to a few of the most popular cryptocurrencies. Combining it with highly limited margin trading possibilities and none of index derivatives (contracts which reflect wide market pricing), we see that many hedging strategies are almost impossible to execute and may only exist as a form of spot arbitrage.

 

 

 

 

 

 

 

 

 

 

 

 

As for market-making, we should notice an almost non-existent derivatives market in the cryptoworld. Even if a few exchanges offer futures and options, they only apply to a few of the most popular cryptocurrencies. Combining it with highly limited margin trading possibilities and none of index derivatives (contracts which reflect wide market pricing), we see that many hedging strategies are almost impossible to execute and may only exist as a form of spot arbitrage.

 

DECENTRALIZATION

The above-mentioned facts are slightly compensated for by the biggest advantage of blockchain currencies – fast and direct transfers around the world without banks intermediation. With cryptoexchange APIs mostly allowing automation of withdrawal requests, it opens up new possibilities for algorithmic asset allocation by much smaller firms than the biggest investment banks. This is important due to two things. Firstly, there is still no one-stop market brokerage solution we know from traditional markets. Secondly, cryptocurrencies trading is distributed among many exchanges around the world. It could therefore be tricky for liquidity seekers and heavy volume execution. It implies there is still much to do for execution algorithms such as smart order routing.

 

CONNECTIVITY

A smart order routing strategy GUI

Another difference is direct market access for algorithmic trading. While on traditional markets DMA is costly, cryptocurrency exchanges provide open APIs for all their customers that may be used without upfront prerequisites. Although adopted protocols are usually easy to implement, they are often too simplistic. They do not usually offer advanced order types. Besides, order life-cycle status following is cumbersome and trading protocols differ among exchanges since each one requires its own implementation logic. That makes a costly technical difference compared to traditional markets with common standards, including FIX protocol.

 

MARKET DATA

Fast, precise and up-to-date data are crucial from an algorithmic trading perspective. When a trader develops algorithms for crypto-trading, she should be aware of a few differences. APIs provided by crypto-exchanges give easy access to time & sales or level II market data for everyone for free. Unfortunately, data protocols used in the crypto space are unreliable and trading venue systems often introduce glitches and disconnections. Moreover, not every exchange supports automatic updates and an algorithm has to issue a request every time it needs to check on the state of a market, which is difficult to reconcile with algorithmic strategies.

The APIs of most exchanges allow downloading of historical time & sale data, which is important in the algorithmic developing process. However, historical level II data are not offered by exchanges. We should also notice that despite being immature, the systems of crypto trading venues are evolving and becoming more and more professional. This forces trading systems to follow and adapt to these changes, which adds big costs to systems’ maintenance. In the following sections I overview a few trading algorithms that are currently popular among crypto algo traders because of the differences between traditional and crypto markets listed above.

 

SMART ORDER ROUTING

Liquidity is and most probably will remain, one of the biggest challenges for cryptocurrency trading. Trading on bitcoin and etherium and all other altcoins with smaller market capitalisation, is split among over 200 different exchanges. Executing a larger volume on any type of assets often requires seeking liquidity on more than one trading venue. To achieve that, cryptocurrency traders may apply smart order routing strategies. These follow limit order books for the same instrument from different exchanges and aggregates them internally. When an investment decision is made, the strategy splits the order among exchanges that offer best prices for the instrument. A well-designed strategy will also manage partially filled orders left in the order book in case some volume disappears before the order has arrived at the market. This strategy could be combined with other execution strategies such as TWAP or VWAP.

Empirica algorithmic trading platform front-end app (TradePad) for crypto-markets.

 

ARBITRAGE

The days when simple crossexchange arbitrage was profitable with manual execution are over. Nowadays price differences among exchanges for the most actively trading crypto-assets, are much smaller than a year ago and transactional and transfer costs (especially for fiat) still remain at a high level. Trading professionals are now focused towards using more sophisticated arbitrage algorithms such as maker-taker or triangular arbitrage. The former works by quoting a buy order on one exchange, based on VWAP for a particular amount of volume from another exchange (the same instrument) decreased by expected fees and return. A strategy is actively moving quoted order and if the passive gets executed, it sends a closing order to the other exchange. As the arbitrage is looking for bid-bid and ask-ask difference and maker fees are often lower, this type of arbitrage strategy is more cost-effective.

Triangular arbitrage may be executed on a single exchange because it is looking for differences among three currency pairs which are connected to each other. To illustrate, let us use this strategy with BTCUSD, ETHUSD and ETHBTC pairs. This strategy keeps following order books of these three instruments. The goal is to find the inefficient quoting and execute trades on three instruments simultaneously. To understand this process, we should notice that ratio between BTCUSD and ETHBTC should reflect the ETHUSD market rate. Contrary to some FX crosses, all cryptocurrency pairs are priced independently. This creates numerous possibilities of using triangular arbitrage in crypto space.

 

MARKET MAKING

Market making should be considered more as a type of business than as just a strategy. The main task of a market maker is to provide liquidity to markets by maintaining bid and ask orders to allow other market participants to trade any time they need. Since narrow spreads and adequate prices are among the biggest
factors of exchange’ attractiveness, market making services are in high demand. On the one hand, crypto exchanges have special offers for liquidity providers, but on the other hand, they require from new coins issuers a market maker before they start listing an altcoin.

These agreements are usually one source of market maker income. Another one is a spread – a difference between a buy and a sell prices provided to the other traders. The activity of a market maker is related to some risks. One of them is inventory imbalance – if a market maker buys much more than sells or sells much more than buys, she stays with an open long or short position and takes portfolio risk, especially on volatile crypto markets. This situation may happen in markets with a strong bias, or when market maker is quoting wrong or delayed prices, which will immediately be exploited by arbitrageurs. To avoid such situations, market makers apply algorithmic solutions such as different types of fair price calculations, trade-outs, hedging, trend and order-flow predictions, etc. Technology and math used in market making algorithms are an interesting subject for future articles.

 

Read more about our tool for market making strategies for crypto exchanges  – Liquidity Engine

 

SUMMARY

Fast developing crypto markets are attracting a growing number of participants, including more and more trading professionals from traditional markets. However, the crypto space has its own specificity such as high decentralization, maturing technology and market structure. Compared to other markets, these differences make some strategies more useful and profitable than others. Arbitrage – even simple cross-exchange is still very popular. Market making services are in high demand. Midsized and large orders involve execution algorithms like smart order routing. At the end of the day to embrace the fast changing crypto environment, one needs algorithmic trading systems with an open architecture that evolves alongside the market.

 

To see the original article click the button on the right.

 

Bitcoin and Arbitrage: hand in hand

Liquidity, the greatest challenge for crypto exchanges

There is a general consensus that liquidity is the most important factor for all tradable markets. The ability or lack thereof, of a market to allow assets to be bought and sold at stable prices, is a major issue associated with cryptocurrencies. 

According to a recent Encrybit report, one in every three investors is worried about the problem of liquidity on crypto exchanges.

 

The importance of the liquidity problem requires tools and methods to manage markets liquidity. This document proposes an approach to monitor and manage liquidity. Monitoring is intended for the exchange management to understand their platform’s current liquidity level and how to improve it. Liquidity management starts with the exchange engaging professional market makers or using proper tools to take care of  liquidity. Last but not least exchanges should track the market impact of trades of different sizes, and oblige their market makers to fulfil certain conditions.

 

Empirica brings experience, tools, know-how and best practices in the area of technology for liquidity analytics and liquidity provision from capital markets to digital assets. We have been active in the market since 2011, working with stock exchanges and market makers with a track record on automated liquidity provision and measurement. 

 

How can an exchange manage its liquidity

 

Both for those who are just launching a new exchange or who have been operating an exchange for some time already, it is crucial to monitor liquidity metrics of all markets.

 

Read more about our tool for monitoring crypto exchange quality – Liquidity Analytics Dashboard

 

As in any tradable market, liquidity is provided by market makers, who mostly use automated market making algorithms. However, crypto exchanges have an alternative to the external market makers, as they are able to take this crucial aspect of exchange – the provision of liquidity – into their own hands.

 

Regardless of whether they use external market makers or an internal market making desk, crypto exchanges should outline to the liquidity providing party certain conditions pertaining to how the liquidity is provided and then constantly monitor the execution of these obligations. 

 

With proper tools, exchanges are able to track liquidity metrics and are able to react accordingly if agreed conditions are not met. Analytic tools also allow exchanges to compare liquidity in their markets to other crypto exchanges.

 

Monitoring liquidity

 

When executing a transaction, most investors only consider explicit transaction costs (taxes, commissions, fees). But that is only a part of the total cost. The larger the trade, the more dominant the part of the cost taken over by implicit costs.

 

Total transaction costs = Explicit transaction costs + Implicit transaction costs

 

One of the most important implicit costs to consider is market impact, also referred to as slippage. Market impact is a result of the price slipping down or edging up when you trade an asset. As the investor can not execute the entire order at the best offer, the trade is moved down the order book.

 

Exchanges, which want to attract not only small but also bigger investors, should monitor market impact and other important liquidity metrics in all of their markets.

 

Liquidity provision

 

To increase liquidity, crypto exchanges use market making services from external parties. This is a standard practice in any financial market.

 

Market makers

 

A market maker is a company or individual that regularly buys and sells financial assets at a publicly quoted price to provide liquidity to the markets. Their role is to satisfy market demand.

 

Crypto exchanges need market makers. If liquidity is low on a venue, exchanges usually try to attract market makers by the following methods:

  • Decreasing maker trading fees
  • Sharing profit from taker fees
  • Paying market makers for their activity

 

It’s  a “chicken or egg” problem. New exchanges and exchanges with low liquidity need market makers to attract other investors. The market makers, however, do not want to enter illiquid markets as there is not much volume to be made from takers and there is also additional business risk involved. Hence many illiquid exchanges need to pay market makers for their services. 

 

While working with crypto exchanges we often hear multiple reasons as to why crypto exchanges are not happy with their market makers. The main problems include:

  • Market makers choosing to support trading pairs that are most liquid; they are not interested in making markets on less liquid pairs
  • Spreads maintained by market makers are too wide
  • Market makers come and go in the markets that they promise to take care of, so exchanges would like to have tools tracking the activity of their liquidity providers
  • Market makers do not keep the order sizes as promised

Liquidity provision tools for crypto exchanges

 

Crypto exchanges have an alternative to market makers, or a complementary approach. They are able to run an automated market making desk themselves. In order to do that, though, they need funds, proper liquidity provision algos and a trader to monitor them.

 

Market making requires a good combination of technology and some trading skills. The algos must be low-latency and capable of scaling to thousands of orders per second, on numerous trading pairs. It needs a disciplined approach to trading and risk management. 

 

There are many market making tools on the market. They range from simple black-box bots to sophisticated algorithmic engines with market making capabilities.

 

When searching for self liquidity provision tools one should be considering the following criteria:

 

  • Reliability

 

Market making algorithms should work 24/7, and be able to recover from unexpected situations like connection problems with an exchange.

 

  • Security

 

Market making systems have  access to the funds of the exchange, so it is important to choose from proven solutions.

 

  • Transparency

 

In the case of black-box algorithms, the bot developers should be widely known in the community. Exchanges should consider skipping bots and going for proven institutional-grade market making solutions available on the market.

 

  • Parametrization

 

In the case of algorithmic market making it is good practice to choose solutions that enable parametrization and tuning up of execution according to the current market situation.

  • Access to source code and custom changes

Ideally crypto exchanges should have an option to take over the market making algorithms source code and let their team develop and tune it further. Very often exchanges might want to add secret sauce to the algorithms that will create their competitive advantage in the market. 

 

Read more about our tool for market making strategies for crypto exchanges  – Liquidity Engine

 

Competing with other exchanges is a challenge today. In July 2019 services like CoinMarketCap or coinpaprika listed about 260 exchanges. However, Empirica’s internal research shows that there are currently more than 600 crypto exchanges in various stages of maturity, and further new exchanges being launched every month. Every exchange is trying to attract new investors, but it is clear that at some point only those exchanges with the best liquidity will survive. That is why crypto venues should not only manage their own liquidity but also observe the liquidity level of their competition, and identify inefficiencies that can be addressed.

 

Empirica specializes in liquidity measurement and liquidity provision software that can help exchanges manage their liquidity. 

A brief guide to cryptocurrency exchanges

With a rapidly growing interest among technologist as well as trader towards cryptocurrencies, we have been writing a series of posts about them. In this post we will be covering cryptocurrency exchanges and point out their characteristics, and hopefully at the end of this post you may get an idea on which crypotocurrency exchange to do your trades.

Generally there are many doubts and question marks around how reliable cryptocurrency exchanges are. There has been a lot of rumors and news also around governments getting involved and closing down cryptocurrency exchanges, we heard that in South Korea  the governments is going to raid the cryptocurrency exchanges operating in the country and shut them down. If you are curious about that story, one of the officials from the government called that an “unrealistic move”. nevertheless in recent times we have heard numerous speculations about cryptocurrency world which never came to life.

The purpose of this post is to assess the most known and used cryptocurrency exchanges. We have chosen arguably the top rated exchanges, basing on fees applied, how safe the exchange is, if liquidity in the exchange is high or not, the possible pairs and currencies to trade with  USD, Euros or crypto with crypto and so on. The list we have gathered is narrowed with qualities indicated above.

Coinbase

Coinbase is one the most known and used exchange for Cryptocurrencies with up to 10 million users. Coinbase was founded in 2012 and is California based Crypto exchange for cryptocurrencies like Bitcoin, Ethereum, Litcoin, Ripple and etc. After introducing GDAX, Coinbase also aimed more sophisticated traders with a more powerful tool. Coinbase is also available for mobile users. Fees charged are around 0.25%.

Bitfinex

Bitfinex is a Hong Kong based cryptocurrency exchange, specialized for trading Bitcoin and Altcoins. About fees, Bitfinex does have very low fees of 0.2% and for those who instead place trades in the order book will pay only 0.1%. Bitfinex is also available for traders to trade using mobile app. Bitfinex offers a variety of order types. For automating the trades Bitfinex also has provided an API feature for third-party softwares to integrate.

Coinmama

Coinmana is a well-known, Israeli based Bitcoin exchanges which traders could purchase Bitcoin using creadit/debit cards. The fees in Coinmama are about 6%, relatively high among other exchanges. Though Coinmama does not require traders to provide or upload their know your customer (KYC) documents.

Kraken

Kraken known as one of the largest Bitcoin exchanges. Kraken’s users can trade Bitcoin using Canadian dollars, US dollars, British Pounds and Japanese yen. Kraken is in Euro volume and liquidity. Kraken was founded in 211 by Jesse Powel, Kraken is also known for low transaction fees ranging from 0% to 0.26% depending on the account tier and the type of the transaction(buy/sell).

Gemini

Gemini is a US based exchange mainly focused on Bitcoin, US dollars and Ethereum. Gemini was founded in 2015 by Winklevoss twins (same brothers who claimed Mark Zuckerberg stole the idea of Facebook from them). Gemini’s users can deposit Bitcoin, Ether and make bank and wire transfer free of charge. In regard to trading fee, Gemini set to charge 0.25% for sellers and buyers. Gemini is referred to as the safest cryptocurrency exchange out there.

More on cryptocurrency exchanges:

Exchange

 

Estimated traffic

 

users

 

Fees

 

Tokens traded

 

Coinbase

 

109M

 

10.1M

 

0.25%

 

Bitcoin, Litecoin, Ethereum, Bitcoin Cash, Ethereum Classic

 

Bitterex

 

85M

 

5.6M

 

0.25%

 

Bitcon, Ubiq, Litecoin, Blackcoin, Dash, Ethereum, Gambit, Gridcoin

 

Bitfinex

 

 

36.5M

 

2.9M

 

0.20% Bitcoin, Ethereum, Ripple, Litecoin, Bitcoin Cash, EOS, NEO, Iota, Ethereum Classic, Monero, Dash, Zcash, OmiseGO and more
Kraken

 

22.6M

 

2.9M

 

0 to 0.26%

 

Bitcoin, Ethereum, Litecoin, Gnosis, EOS, Dogecoin, Tether, Melon, Zcash, Augur tokens, Iconomi, Stellar, Ethereum classic, Ripple, Monero, Dash

 

Okex

 

 

3.5M

 

350K

 

0.20% to 0.25% CommerceBlock, Revain, Bitcoin, Chatcoin, Gifto, Zipper, Ethereum, Zencash and more
Gdax

 

46M

 

4.5M

 

0.25%

 

Bitcoin, Bitcoin Cash, Litecoin, Ethereum
CEX

 

10.8M

 

1.6m

 

3.9%

 

Bitcoin, Ethereum, Bitcoin Cash, Litcoin
Gemini

 

3.4M

 

111K

 

0.25%

 

Bitcoin, Ethereum
Coinmama

 

999K

 

33.4K

 

6%

 

Bitcoin, Ethereum

 

Free version of Algorithmic Trading Platform for retail investors

We have just released beta of Empirica – Algorithmic Trading Paltform for retail investors! It’s lifetime free for development, testing and optimizing of trading algorithms.

Our development team (exactly this team who implemented the entire system) also provides full support in algorithms development as well as connectivity to brokers. If you need help just contact us.

Among many features what is unique is our exchange simulation where you can influence market conditions under which you test your algorithms. No others software offers such a realistic level of simulation.

In paid versions we offer the execution of algorithms in robust server side architecture.

We strive for your feedback!

Best regards,

Michal Rozanski
Founder and CEO at Empirica
twitter: @MichalRoza
https://empirica.io


Empirica Trading Platform – https://empirica.io