Adverse selection in cryptocurrency markets
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In this article we investigate the influence that information asymmetry may have on future volatility, liquidity, market toxicity, and returns within cryptocurrency markets. We use the adverse-selection component of the effective spread as a proxy for overall information asymmetry. Using order and trade data from the Bitfinex exchange, we first document statistically significant adverse-selection costs for major cryptocurrencies. Also, our results suggest that adverse-selection costs, on average, correspond to 10% of the estimated effective spread, indicating an economically significant impact of adverse-selection risk on transaction costs in cryptocurrency markets. Finally, we document that adverse-selection costs are important predictors of intraday volatility, liquidity, market toxicity, and returns.