Building trust takes time: limits to arbitrage for blockchain-based assets

Nikolaus Hautsch, Christoph Scheu and Stefan Voigt

Review of Finance, 2024, vol. 28, issue 4, 1345-1381

Abstract: A blockchain replaces central counterparties with time-consuming consensus protocols to record the transfer of ownership. This settlement latency slows cross-exchange trading, exposing arbitrageurs to price risk. Off-chain settlement, instead, exposes arbitrageurs to costly default risk. We show with Bitcoin network and order book data that cross-exchange price differences coincide with periods of high settlement latency, asset flows chase arbitrage opportunities, and price differences across exchanges with low default risk are smaller. Blockchain-based trading thus faces a dilemma: Reliable consensus protocols require time-consuming settlement latency, leading to arbitrage limits. Circumventing such arbitrage costs is possible only by reinstalling trusted intermediation, which mitigates default risk.

Keywords: arbitrage; blockchain; market frictions (search for similar items in EconPapers)
JEL-codes: G00 G10 G14 (search for similar items in EconPapers)
Date: 2024
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Working Paper: Building Trust Takes Time: Limits to Arbitrage for Blockchain-Based Assets (2023)
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