The Ethereum Foundation (EF) is stepping its game up with the number of significant news announcements coming out of Devcon Two and ETH is responding, up 21% over the past 2 days. Devcon Two is the official Ethereum conference, currently held in Shanghai where “the Foundation’s own team of developers and researchers emerge from their dev caves to present and discuss their most current work and innovations”.

Some of the more interesting highlights (apart from Vitalik’s cat bag and immense usage of Doge) that I see positive for ETH:

• A Focus on Smart Contract Security: Seems the EF is learning through (epic) failure. A number of sessions have been dedicated to security on Ethereum and DAPPs, could this be a revival of faith in decentralised autonomous organisations?
• Zcash Integration: The ability to use Ethereum contracts to send and receive Zcash and also meaning that transactions can be conducted in private.
• Santander Integration: Huge news from one of the world’s largest banks, Santander will allow customers to turn bank account funds into Ethereum based tokens.

It is clear from the chart above the divergence between ETH and ETC since the start of the conference. The core concept behind Ethereum Classic is to remain immutable, no forks, no bailouts, no going back. Large corporations, and clearly large banks such as Santander, are not going to invest in this train of thought. The idea of a bailout is attractive in case things go wrong and heads are about to roll. If money is pouring in from corporations to attract talent, resolute devs are going to go hungry.

There will be more to come over the next few days from the conference, and I see more divergence ahead. One in particular, as I used to use the service every day, is the Ethereum Blockchain Initiatives at Thompson Reuters.

The clear trade is to go long ETH and short ETC. On BitMEX we offer 33x leverage on ETHXBT and 10x onETC7D. Play the FOMO to the end of the conference and look for a close before the end of the week.

Betamax vs VHS, Coke vs Pepsi, Ring Signatures vs zk-SNARKs; the choice for a winner in the battle for online cryptocurrency privacy is not so clear cut. We see two main contenders: Zcash and Monero.

Zcash hasn’t launched yet but is making waves, featuring a new privacy method that has not been used in any other coin. Zcash implements the Zerocash protocol, which is an evolution of Zerocoin, a protocol prominent in 2013 but never mainstream. Zerocash’s main draw is transaction size; Zerocash can make transactions up to 98% smaller than Zerocoin through a novel method. This method is known as a zk-SNARK (zero-knowledge Succinct Non-interactive ARgument of Knowledge). zk-SNARKs allow Zcash to feature completely opaque addresses and transactions, while keeping proof size small. From their protocol spec:

“The basis of the privacy properties of Zcash is that when a note is spent, the spender only proves that some commitment for it had been revealed, without revealing which one. This implies that a spent note cannot be linked to the transaction in which it was created. That is, from an adversary’s point of view the set of possibilities for a given note input to a transaction—its note traceability set— includes all previous notes that the adversary does not control or know to have been spent.”

Users are hopeful but skeptical. There may be too much anonymity; transactions can’t be traced to the genesis block. In the wild, there could be more coins mined than claimed by the devs – only a thorough review of the source code & proof that all parties are running the same code could verify. Zcash also requires a “trusted setup”, essentially a seeding of key data, that has attracted criticism. The technology is new and untested; like Bitcoin in 2009, it has yet to be proven, and few understand the implementation.

Zcash is attempting to integrate with other chains. Zooko Wilcox O’Hearn, one of Zcash’s technology leads, describes “Project Alchemy”, an attempt to connect the Zcash blockchain and the Ethereum blockchain. “You [can] create a decentralised exchange right there,” Zooko writes. “It means you can create unshutdownable things. It also means when you add this new power – to send and receive Zcash – all the other Ethereum contracts gain this new power.”

What about Monero? Monero has had a head start in this race. Monero’s ensures privacy via Ring Signatures. In short, it is based on mixing transactions with other transactions. This method of privacy is tried and tested in Bitcoin mixers, but mixers are explicit and coins coming from them are often blacklisted. Monero’s mixing is implicit and constant, significantly improving privacy.

Monero is not without issues. The set of mixed transactions is smaller than that of Zcash (where your transaction is hidden amongst all outstanding transactions), and mixing more coins requires a larger transaction size and thus slower transactions.

Both coins seek to solve other Bitcoin issues.

Monero has no block size limit nor any built-in reward halving. Zcash seeks to prevent a mining cascade at launch by slowing scaling up rewards in the first weeks. Both have faster block timings, and both use hashes designed to disadvantage GPU and ASIC mining.

Both coins desire to keep mining decentralized by reducing the GPU and ASIC advantage. Monero hasCryptoNight, which is designed to be fast on a CPU but slow on a GPU. This is effective in reducing GPU hashrate – the latest & greatest GPUs only have a very small scale advantage over fast CPUs. Zcash tackles the same problem with Equihash, a tunable hash algorithm that is designed to require massive amounts of memory, thus being almost entirely unusable on all but the very fastest GPUs. No GPU miner has yet been released forEquihash.

Which will capture hearts & minds? Usability may be the decider. Monero users have been waiting years for a simple GUI wallet. Monero is a completely new currency and thus has few tools. Zcash, on the other hand, isforked directly from Bitcoin and already has GUI wallets and even a block explorer forked from Bitpay’s popular Bitcore project. If the Zcash team is able to deliver fast and quality development, they may see users switch quickly.

Zcash is not yet launched, but you can already trade it, exclusively on BitMEX. We have launched a future,ZECZ16, that will settle on the largest underlying spot market’s price with expiry Dec 30, 2016. Bullish on Zcoin vs Monero? You can long the Zcoin ZECZ16 contract & short the Monero XMR7D contract (or vice versa), using BitMEX today.

7 years on, Bitcoin still remains the largest cryptocurrency by market capitalisation (market cap). While Bitcoin may have been the most volatile currency, it has since ceded that mantal to up and coming altcoins.

The transformation of Bitcoin from a volatile experiment, to a “stable” form of electronic money is illustrated in Figure 1. Figure 1 plots the 90 day moving average market cap of Bitcoin against its 90 day realised volatility.

Volatility peaked alongside the market cap during the 2013 bubble. Over the past 3 years, the market cap fell substantially then surpassed the 2013 high earlier this year. During the same period, volatility fell and continued falling.

The holy grail for many users is a cryptocurrency that has a growing market cap, and falling price volatility. A large market cap helps improve liquidity and reduce transactions costs. Falling volatility means that Bitcoin can retain its value for longer periods of time. That helps facilitate its adoption in online commerce and as an asset used as a savings vehicle.

Bitcoin’s march towards reserve status is not welcomed by all. Many speculators, who account for a significant portion of trading volumes, prefer very volatile cryptocurrencies. Short-term trades with high leverage can yield stupendous returns. As Bitcoin’s volatility falls, it becomes boring and speculators search for the next hot altcoin.

The solution to a boring coin is more leverage. Given the increasing liquidity, leverage offered by platforms like BitMEX and our competitors will increase to retain the attention of speculators. If the volatility keeps falling, 500x and 1,000x leveraged trading will become increasingly popular.

Regardless of the form, increased leveraged trading via derivatives bleeds into the spot market. Market makers must buy or sell the underlying asset to remain hedged and earn the Bid / Ask spread. Increased spot trading volumes help commercial users of Bitcoin reduce their transactions costs. More commercial users, means greater adoption, and hopefully a higher price.

The Next Frontier

Ether, the token that rides on the Ethereum blockchain, was a boring altcoin until early 2016. The price spiked over 1,000% in a few months. Figure 2 is the ratio between Ether and Bitcoin’s realised 90 day volatility. The ridiculous volatility drove on-exchange trading volumes over that of Bitcoin for a short time.

Ether’s market cap surged to a high of US$1 billion in the Spring of this year. The smaller market cap means that it is easier to push the price around. Large whales can cause significant price volatility using relatively little capital. Many think this is counterproductive to a successful currency. But without greedy and impatient speculators, where will the liquidity come from?

Monero’s impressive rise from obscurity has captivated traders over the past month. Figure 3 is the 7 day realised volatility of Monero. At times, Monero has become the most traded product on BitMEX. Traders are flocking to the Monero futures contract, XMR7D, because the price can move by percentage points within a few minutes. With 10x leverage, you can double your stack quite quickly.

Bitcoin illustrates that for any coin to be successful, speculators must be attracted first by high volatility. The coin may be illiquid, but that is exactly what produces the wild price swings that keeps traders captivated. Volatility is the best form of advertising. A coin that is not volatile has either died, or is on the path towards reserve status like Bitcoin.

It is telling that the most liquid pair for any altcoin, is its exchange rate vs. Bitcoin. At the end of the day speculators want their profit denominated in the world’s most “stable” cryptocurrency.

Data Sources:

Figure 1, Quandl

Figure 2, ETH BitMEX and Bitcoin Quandl

Figure 3, BitMEX

Figure 1.

Short CNY and long Bitcoin has been a good trade over the past 18 months. As seen in Figure 2 below, the Chinese currency has depreciated to a 6-year low of 6.68087 against the US Dollar, with CNH (the offshore freely traded version) trading at levels of 6.6833. The premium between XBT/CNY and XBT/USD is trading relatively weak however, currently pricing at a small discount as seen in Figure 1 above. With analysts predicting further devaluation in the Yuan, we are on course to see a continuation of this bullish trend in Bitcoin and a pick-up in the premium.

Figure 2.

CLSA, a brokerage and investment group known for their Asian research, predicted back in April that the CNY will head towards 8.00 by the end of next year. More recently, a Reuters Poll conducted in late August of over 60 FX strategists showed a more conservative, yet still bearish case, that the CNY is expected to depreciate to 6.80 by the end of February and by the end of August 2017 further weakness to 6.89.

As the chances of the Fed raising rates increase, and once they eventually do raise rates (whether before or after the election), the USD will strengthen (as it has been recently). This makes it harder for China to keep the currency pegged to the greenback as they need to sell their reserves to support the Yuan. Further depletion will prompt China to adopt a free-float regime which could cause immediate selling in the Yuan, as traders are free to price their views on the impending issues in China such as the much-anticipated debt bubble.

As Chinese become more and more concerned about the value of their local assets they will continue to look for ways to convert into another currency or asset. One method the Chinese have used is known as the EB-5 Immigrant Investor Program, allowing foreign investors to obtain a US green card and investing in the US at their will, by first investing in specific US based projects (predominantly real estate projects such as apartment complexes and shopping malls). This method has taken a hit over the years given the restriction on capital flows out of China. In fact I have had several US firms approach me enquiring about Bitcoin as a “legal” method for moving funds out and into their programs. However, at high premium above 3% this approach becomes unattractive for these firms.

The current cheap premium entwined with the impending rate rise may be the trigger to spur another round of purchasing by the Chinese, pushing the premium and bitcoin up with it.

After the biggest money-printing episode ever recorded in human history, it appears that central bankers are realising the limits of quantitative easing. The Federal Reserve (Fed) has indicated that they are planning to raise interest rates. The Fed next meets on the 20-21st of this month.

Grandma Yellen indicated September and December rate hikes are on the table. Some analysts expect the Federal Funds rate to increase by 0.50% by year end.

Apart from banks and insurance companies, increased rates are not welcomed. Non-financial corporates have gorged on free money to complete stock buybacks and M&A deals. Higher borrowing costs will be disastrous for their highly levered balance sheets. That is why equity indices react negatively to any hint that the punch bowl will be removed.

Bitcoin dances to the beat of the PBOC. As I have written about on numerous occasions, the PBOC is staring at a banking system collapse of epic proportions. The amount of credit extended in the past eight years dwarfs the amount extended during the US Subprime Mortgage crisis by multiples.

As long as the Fed keeps rates low, the PBOC is able to quietly and slowly deleverage China’s collective balance sheet. A stronger USD makes Chinese goods more expensive globally. It also encourages more capital flight into a “safer” and stronger currency.

Each day at 9:15am Beijing time, the PBOC sets the USDCNY onshore exchange rate. Since August 2015, any time the Fed has hinted at or raised rates the PBOC has accelerated the devaluation of the Yuan. A devaluing Yuan signals that the global economy is not well, and deflation is being exported by the workshop of the world. That is not positive. As a result, during periods of Yuan depreciation, global equity markets fall.

Through quantitative easing the Fed attempts to push American savers and corporates into equity markets. Due to the lack of positive risk-adjusted and inflation-adjusted yielding assets, savers and corporates have responded correctly. The S&P500 is at all time nominal highs, and the US equity market has been one of the best performing markets globally since the Global Financial Crisis in 2008.

Given that a significant percentage S&P500 earnings are international, a faltering China signals global malaise. As such the index trades violently lower. When the S&P500 is falling, the Fed is in panic mode. It forces the same savers and corporates to dump shares in favor of cash. This cash will sit in a bank account, and the demand for credit will fall.

After a sufficient fall in the S&P500, the Fed relents and proclaims due to “market forces” the time just isn’t right for a rate hike. The PBOC then halts the devaluation, and the game continues into the next quarter.

Yellen’s Jackson Hole remarks were very hawkish. The rhetoric was subsequently backed up by various Fed governors during public speeches. The PBOC noticed and began weakening the Yuan towards 6.70.

If the hawkish rhetoric translates into action, the PBOC will allow onshore USDCNY and offshore USDCNH to trade much higher (the higher the level, the weaker the Yuan). Bitcoin reacts positively to a weaker Yuan.

If the Fed’s threats of a rate hike are perceived as credible, the market will attempt to front run the PBOC and short the Yuan by selling offshore CNH. In response, the PBOC instructed state owned Chinese banks to restrict lending of CNH in order to drive up the cost of funds. [Bloomberg] If you want to short CNH, you usually borrow it from one of the large Chinese banks. If the interbank CNH rates become prohibitively expensive, shorts are forced to cover.

Watch USDCNH, the PBOC has been defending 6.70 in the offshore market. If they allow that level to be breached, it means they are willing to tolerate a much weaker Yuan. Bitcoin will soar.

The best hope for a retaking of $700 and then $800 is for the Fed to raise rates next week. If the S&P500 nose dives before the meeting then the Fed will not hike, and all attention will shift to the December meeting.