The Impact of Tick Sizes on Trader Behavior: Evidence from Cryptocurrency Exchanges

This paper analyses the effect of a tick size on a major cryptocurrency exchange where spreads are unconstrained, assets have limited fundamental value and tick sizes are extremely small, which facilitates undercutting. Using a unique high frequency dataset and a significant increase in tick sizes on the cryptocurrency exchange Kraken, we find that undercutting decreases, leading to traders posting more and larger limit orders. Transaction costs and short-term volatility both decrease, contrary to previous findings in equity markets. We show market quality can be improved by increasing extremely small tick sizes. Our findings contribute to the optimal tick size debate, with particular implications for cryptocurrency and foreign exchange markets, where tick sizes are typically very small.