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Understanding runaway markets

Werner van Rooyen
7 minute read

As Bitcoin and Ethereum continue their record-breaking run over the past few weeks, we’d like to take a moment during this euphoria to explain the dynamics of runaway markets and how to protect yourself against transactions you might come to regret. Investment decisions don’t start with deposits or purchases, they should start with education.

Stop

The price you see

The price of digital currencies like Bitcoin and Ethereum is determined by supply and demand: people who want it (buyers) and people who have it (sellers). Luno is the platform connecting these buyers and sellers; Luno does not determine the price of Bitcoin or Ethereum.

During surge periods, like over the past week, demand is much higher than supply since more and more people want digital currency and, something most people prefer not to see, just because the price is going up.

 

7-day price increase on Luno

Recent price increase on Luno

When you buy BTC or ETH on the Luno platform, you are buying it from someone else (called the “counterparty”). This counterparty is a little more complicated than just saying “someone else”, since we are often connected to multiple sources of liquidity (i.e. marketplaces where people buy and sell digital currencies). You could just be making one big purchase, but you’re buying from multiple sellers, who, depending on which country you are in, could even be from multiple other countries. However, the same rule of supply and demand still applies.

Supply and demand on Luno

Supply and demand on Luno

Digital currency platforms, like Luno, also operate independently from all other digital currency platforms:

Supply and demand

Supply and demand on Luno, independent from other platforms

You can see here how the price of Bitcoin (when measured in USD) is technically different on each and every Bitcoin platform around the world. This is simply because supply and demand are different on each of those platforms.

Arbitrage

If the price is slightly higher on one platform, traders (i.e. external parties, not Luno) will sell on that platform and buy on another lower-priced platform. This process is called arbitrage and exists in almost all markets, financial or otherwise. In theory, this is meant to create price parity across platforms, but in practice, it doesn’t always work that way due to constraints like capital controls, the difficulty of moving of local currencies, market timing, fees, liquidity and so on.

On runaway prices

Downswings

Sometimes we may witness an event that triggers a big event on a certain platform. If, say, Platform B sends out an email that they are experiencing many technical issues, their customers might panic about the safety of their funds and immediately sell all their Bitcoin (so, supply will be higher than demand). This will push the price down on that platform, whereas it might stay unchanged on other platforms.

Upswings

The opposite also holds true: customers on one platform might be very enthusiastic about the price of digital currency and this increase in demand will push up the prices on that platform, whereas it might stay unchanged on other platforms or in particular countries.

The differences in price between platforms vary: sometimes it’s a small amount, sometimes it can be much more substantial. Eventually, the price again reaches some sort of equilibrium with a smaller difference between them.

Markets are efficient, but they aren’t always rational. It could be argued that the faster the surge or plunge in price, the less rational the market becomes, with many people taking the same action at the same time.

Understanding supply and slippage

When you buy digital currency on Luno (or on other platforms) it’s important to realise that:

  1. You are buying from another person or multiple people (the counterparty)
  2. There isn’t an unlimited amount of digital currency available at the current price

If you put a hundred people, each with one Bitcoin (1 BTC) that they want to sell (the supply side)  in a room and you bring in a buyer with unlimited money who wants to buy 100 BTC (the demand side) the 100 sellers will quickly start arranging, each seller setting their price. Some sellers might set their price close to the market rate of $10,000, some might set it at $11,000 and so on. Some might even say, “No, I think this thing I have is worth more, I’m only selling at $100,000 or even $1m”.

If the single buyer just says “I agree to buy 100 BTC at the current market rate” they will automatically buy all the bitcoin from all the sellers, some of it at $10,000, some of it at $1m.

This might seem like an extreme example, but digital currencies are much, much smaller than other financial markets. Even relatively modest buy or sell transactions using digital currency could see the effect of slippage.

It is therefore crucial that you closely review the final price you are quoted when buying Bitcoin or Ethereum. We will always show you the price you will pay and the amount you will receive in return before you confirm the transaction - it is shown right at the top of the Luno app or screen.

Exchange rates —on Luno and elsewhere— are always just indicative. This is why we show you a confirmation screen before you complete a transaction.

Buyer’s remorse

Occasionally during these runaway prices —up or down— we find that some customers are upset about the high price they paid (or the low price they received) for their digital currency.

We want to make it clear: Luno doesn’t set the price and we don’t benefit from individual transactions that are higher or lower than the expected market price. Luno only levies a small fee for each successful transaction. The ‘higher’ or ‘lower’ values paid are a function of the market and is settled between these respective counterparties.

Since transactions aren’t between, say, a buyer and Luno, but between a buyer and a seller, it is impossible to reverse or refund a transaction. Reversing a Bitcoin purchase would mean we need to reverse transactions not just on the buyer’s account, but on one, two or one hundred sellers’ accounts, who all already agreed to the price on that transaction in the first place.

Again, this is not just the case with Bitcoin, but with other financial instruments such as stocks, bonds, the housing market and so on. People who trade a lot of these instruments are very familiar with these dynamics and if you are not an experienced trader or investor, it’s very important that you familiarise yourself with this.

Easy does it

Some people say that when the market is buying (moving up) that you should sell and when it is selling (moving down) you should buy. We can’t and won’t give trading advice, but it’s important to highlight a few things:

1. Learn as much as you can

As the adage goes: don’t invest in anything you don’t understand. The more you want to invest, the more you should know about the subject matter. If you’re only spending the equivalent of a meal, you can probably go ahead and buy some without over-thinking it. If you lost that amount, it wouldn’t be the end of the world. But, if you’re investing a substantial amount, you must arm yourself with some information on how things work.

money-and-time

2. Take it easy

People tend to make irrational decisions when things are moving fast. Consider slowing down and setting a few rules in place, such as:

  • I will only allocate x% of my investment portfolio to digital currency each month
  • I will only buy digital currency with money I can afford to lose
  • I will never buy digital currency at an all-time high, only sell ;-)
  • I will only buy or sell after closely reviewing what the final price is

If you’re investing without a strategy, you’re not investing, you’re gambling.

3. Expect delays

The price of Bitcoin has increased by over 1200% in the past year, Ethereum even more so. No matter how fast digital currency platforms like Luno grow, it’s impossible to grow your staff at the same rate. The wheels will simply come off if you tried that.

Just by way of example: if we have one customer support agent that can help a one hundred customers, and we suddenly have hundreds of thousands of customers signing up (as has been the case), there is no way to hire customer support staff at the same rate as the influx of new customers, no matter how hard we try. This is why so many customers unfortunately experience support issues in periods of high volatility and in fast-growing industries such as ours.

Also note that it’s critical that we only employ the best and brightest for Team Luno because it’s a highly complex industry that requires a lot of training and checks to make sure you are given the right advice, the right help and that your money is safe with us. We can’t simply employ anyone and everyone.  We are hiring as fast as we can to clear the bottlenecks that come with an influx of customer signups, community and social engagements, resolution of queries and improving the performance of our platform to our customers across the world.

We’re really sorry about the delays you experience during these times of runaway prices. We’re working as hard as we can —until late at night and through the weekend— to get to your issues. It will get resolved, but it may take longer than normal.

When there is an exponential increase in traffic on our platform, you also may experience degraded performance with the occasional delay as we upgrade and ensure stability in the system. Again, we working hard at smoothing out these technical kinks, too.

We’ll send more communication about our scaling roadmap for 2018 later this year.

Summary

We’d like to say thanks to all our customers, all over the world, for your continued support. We’re witnessing a time of unprecedented interest in digital currencies and we’re proud to have so many people form part of this wave; something we ultimately see as the future of finance.

We’re planning on increasing the number of educational resources for our customers in the coming months to always be the easiest way to buy, sell (and yes) learn about digital currencies.

To the moon.

Avatar Werner van Rooyen
Author

Werner van Rooyen

Werner heads up Business Development and Marketing at Luno. His passions include payments, e-commerce, technology, marketing and design: something that he has been fortunate enough to do on three different continents. Werner has lived and worked in South Africa, the United States, Indonesia, Taiwan and China.

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