Cryptocurrency liquidity during extreme price movements: is there a problem with virtual money?

The enormous rise of the cryptocurrencies over the last few years has created one of the largest unregulated markets in the world. In this study, we obtain millisecond data for the five major cryptocurrencies—bitcoin, ethereum, ripple, litecoin and dash—and two cryptocurrency indices—Crypto Index (CRIX) and CCI30 Crypto Currencies Index—to investigate the relationship between cryptocurrency liquidity, herding behaviour and profitability during periods of extreme price movements (EPMs). We demonstrate that cryptocurrency traders (CTs) facilitate EPMs and demand liquidity even during the utmost EPMs. We observe the presence of herding behaviour during up markets across the entire dataset. Our robustness checks indicate that herding behaviour follows a dynamic pattern that varies over time with decreasing magnitude. We also provide novel evidence of CTs’ profitability after transaction costs, and demonstrate their strong profitability-generating record in the future.