TradeBlock’s XBX index is an institutional-quality reference rate for the USD-denominated price of bitcoin. XBX is currently licensed to TradeBlock clients who use it as the reference rate for tens of millions of dollars in outstanding bitcoin derivative assets. Limited historical data for the index is now available to the broader public as well. The below overview offers a conceptual explanation of the algorithm underlying XBX and an explanation of why a truly robust index is necessary for this market.
Need for a Robust Reference
As digital currency markets continue to evolve and grow, so too does the need for instruments to help increasingly-sophisticated investors manage risk. Derivatives such as swaps, futures, trusts, and bespoke contracts enable hedging and indirect financial exposure to bitcoin, attracting new capital which should ultimately translate into greater liquidity in underlying spot markets as well.
The unique dynamics of digital currency markets make it less than straightforward to determine a reliable and broadly-applicable price of bitcoin at a given moment. Large spreads between rates at different exchanges and near-zero visibility of large, off-exchange trades mean widely varying data inputs. Looking at the world’s highest-volume exchanges, it’s not uncommon to see spreads of 2-5% or more, particularly during periods of high volatility.
Moreover, low liquidity in spot markets results in high susceptibility to price manipulation if a single exchange’s rate or more rudimentary index is used as a reference. With only a few million dollars worth of orders open at even the most liquid exchanges, the capital required to substantially move spot rates at a single exchange is relatively nominal, particularly if it would affect the outcome of a much larger derivative contract.
Also not to be overlooked is the frequency of single-venue anomalies, wherein the rate at one exchange diverges substantially from the others. Historically this has played out in dramatic fashion, as witnessed when the price of bitcoin at Mt. Gox famously fell to 20% of the price on other exchanges earlier this year. In fact, over the last three months, each of the top three XBT / USD exchanges has experienced similar events where price at those venues diverged more than 10% from the rest of the market. (see Index Performance section below for detailed examples). In such a scenario, the rate at the divergent exchange clearly represents a dynamic of that particular venue, rather than the market as a whole.
TradeBlock draws from a variety of data sources to make the XBX index the market’s most robust, institutionally-focused reference rate. In addition to data from various global exchanges, TradeBlock is also the only company in the world able to incorporate significant volumes of large, verified, off-exchange trades, the data for which is obtained through unique agreements with our institutional clients.
The openness and technical robustness of bitcoin’s underlying technology makes creating a digital currency exchange relatively easy. That said, creating a reliable exchange with notable liquidity and reliable data is far more difficult, so simply incorporating all possible exchanges would be inappropriate for an institutional-quality index. Conversely, creating rigid requirements for inclusion oversimplifies an extremely dynamic and quickly evolving market. For those reasons, TradeBlock uses the following criteria as guidelines, but not mandatory requirements, for inclusion in XBX:
- Liquid market in the XBT / USD cross
- Acceptance of USD deposits
- Reliable data API
- Domiciled in the United States
- Investment from reputable venture capital firms
- Compliance with relevant regulations
With each constituent data source indicating a different price of bitcoin, the weighting of each input on XBX must be carefully considered. Accordingly, TradeBlock employs a proprietary algorithm to ensure XBX serves as an appropriate reference in all market environments.
To calculate XBX, all data is immediately cleansed and validated to ensure the reliability of any contributing trades. Data from all inputs are then weighted against one another based on each venue’s recent- and long-term trading volume and the variance in price across all data points. The result is a reference rate that follows market liquidity in real time, while discounting any sort of anomalous trading. The index can then also be used to create additional reference calculations, such as volume- or time-weighted rates based on the same algorithm.
In particular, XBX provides robust protection against manipulation. Any attempts to move the index would require sustained maintenance of price impact across global trading venues, including validated OTC markets. This makes manipulation of XBX logistically improbable and prohibitively expensive.
While the exact algorithm behind XBX remains proprietary, the performance of the index speaks for itself. The examples below highlight the anti-fragility of XBX and the market-leading protection it provides to our licensees.
On August 14 of this year, the XBT / USD rate on Bitfinex dropped to $465 while the rest of the market remained comfortably above $500. Clearly, the price at Bitfinex that day represented a scenario unique to that exchange. With extremely high volume during that event, its impact on a more rudimentary index would be profound. As shown by the charts below, the XBX algorithm immediately de-weighted Bitfinex, minimizing its impact on the index.
Just a few days later, a similar divergence occurred on BTC-e, another leading bitcoin exchange, as rates there tumbled to the low $300s while all other exchanges remained at or above $450. Again, TradeBlock’s XBX algorithm automatically discounted BTC-e’s influence in real time during this event, preventing it from distorting the index.
To learn more about the XBX index, please email us at firstname.lastname@example.org.