First DCO, Then ETF

Congratulations to Paul and Juthica at LedgerX for reaching the promised land!

There are 16 registered Derivatives Clearing Organisations (DCO) in America. This week the CFTC approved LedgerX’s application to become the 17th active DCO. LedgerX specifically focuses on Bitcoin related derivatives. This is a monumental shift in attitude of US regulators towards Bitcoin and the digital currency industry as a whole.

The CFTC deems LedgerX capable of safely storing significant amounts of Bitcoin on behalf of exchange members. One of the biggest concerns that any regulator has is how a regulated entity will handle Bitcoin storage. The various exchange hacks over the years proves that Bitcoin custody is a dangerous endeavour. Should this happen, the loss of face will surely end the career of the bureaucrat in charge.

Only large trading accounts can become authorised participants on LedgerX. To trade on LedgerX, participants must have several millions of dollars in cash. That restricts the universe of traders to large financial institutions. The popularity of the exchange come launch will provide clues as to the appetite of banks and large trading houses towards Bitcoin.

The regulatory stamp of approval does not mean LedgerX won’t get hacked; it provides convenient cover in case they do. If a financial institution trades on LedgerX and Bitcoins are lost, they can wash their hands of the loss because they traded with a regulated institution.

CFTC raises one Bitcoin DCO, action to the SEC

If the CFTC is looking towards the future of finance, what conversations are big dogs at the SEC having? Can they sit back and continue to deny applications for ETFs? They can’t claim Bitcoin is unsafe, for their sister regulator body has deemed them so. They can’t claim that Bitcoin provenance presents an issue for a retail traded product, for a regulated DCO holds Bitcoin.

It is naive to assume the CFTC and SEC heads do not break bread. Traditional equity, fixed income, and commodity listed products’ trading volumes are declining. Banks’ quarterly earnings reports point to a secular decline in equity, fixed income, and commodity trading volumes. As I have repeatedly said, Bitcoin and digital currency trading represents the fastest growing fee pool globally.

The regulatory bodies are slaves of the TBTF financial institutions. One way or another they will earn fees from digital currency trading. The disdain previously shown by bank chieftains is purely for public consumption.

2017 proves without a doubt that facilitating trading and providing financial services for digital currencies is a viable long term business. Hundreds of millions of dollars in fees earned on an industry with a sub-$100B market cap is truly astounding. The demand for a subset of non-correlated assets will force banks to play ball.

Mere retail mortals cannot trade on LedgerX. However, we should be excited for the messiah, an ETF. The SEC cannot continue to be a prude rose. I predict that one or more applications for an ETF will be approved within the next 18 months.


Bend Over or Hard Fork

Quick Recap

In May 2016, the team dreamed up a genius way to raise money for their project without prostrating themselves before VC firms. They created a Decentralised Autonomous Organisation (DAO) that raised money from investors in the form of Ether. Each investor became a limited partner (LP) of the DAO. An Ethereum smart contract governed the DAO whereby LPs voted on which projects to fund. Conveniently the first and most popular project was

The DAO raised $150 million of ETH, and at the time was the largest crowdfunding project in human history. Unfortunately the DAO’s smart contract was written poorly, and an individual was able to siphon off a third of the AUM by exploiting a flaw in the code.

“Code is Law” – the mantra of DAO cheerleaders, which included Vitalik and his acolytes at the Ethereum Foundation. Their blind faith in shoddy smart contract code landed them in a bind.

Should the foundation use its political capital to persuade exchanges, miners, and holders to accept an Ethereum hard fork to bail out greedy punters? The foundation chose Yes, breaking the first commandment of DAOs: hard forking Ethereum so that the DAO never happened.

Many in the community, especially exchanges, were not pleased that the Ethereum Foundation bailed out DAO investors. The foundation naively assumed no one would want to want the own the chain that contained the tainted DAO. Poloniex saw an opportunity, and listed Ethereum Classic (ETC). The rest is history.

The Present Day

This week the SEC ruled that the DAO was a collective investment scheme, and thus a security. They did not bring any enforcement action against the promoters or exchanges that allowed trading of the DAO, they just issued caution.

The SEC displayed a great deal of restraint by not perp-walking principals at and or the Ethereum Foundation.

Shortly after the hard fork, rumours began circulating that the SEC pressured the Foundation to rewrite history via a hard fork. The threat was clear: face a civil or criminal action for sponsoring and selling unlicensed securities, or hard fork. Given the recent inaction by the SEC, there is serious weight to these allegations.

Step back and think about it. The SEC may have created ETC. How ironic.

Many of the truly innovative and disruptive applications built on the Ethereum protocol will challenge the supremacy of governments in various industries. However, going on one year since the bending over, is Ethereum decentralised enough now to weather concerted action against it by a concerned government regulator? Would the foundation, under government pressure, attempt another hard fork to remove an application that is subversive to a powerful agency.

For those who invest heavily in “disruptive” Ethereum based projects, this chain of events should give them pause. Their new and shiny token might be obliterated by an alphabet letter agency dangling the prospect of government sanctioned rape in front of scared founders. Bend over, or hard fork.

What’s Next for ICOs?

The SEC did not pass judgement on all ICOs. Rather they clarified that if your token is clearly a security, don’t play in the US. Most ICO projects go to great length to avoid this scarlet letter.

This action will certainly dampen investor enthusiasm for a time; however, the underlying premise of selling usage rights in an application is unchallenged. The world will see fewer ICOs with equity like features, but after the DAO those types of deals were never the most popular anyway.

Tezos, Eos, and Bancor are the top three ICOs of 2017 in terms of money raised. All of them are protocols to perform a set of tasks. None of these tokens are collective investment schemes, or provide the owner with rights in a privately listed company. Keep calm, and party like it’s 1999.

Trader Interview – ETFdeniedbot

ETFdeniedbot has been BitMEX’s top performing trader this year. Active since March, he has achieved a return on his capital at BitMEX of 23225.66%. He did not just have one lucky win at 100x – he has consistently hit it out of the park. It is rare to find such a trader. We reached out to him and he kindly agreed to an interview. Keep an eye out for him in the Trollbox as he is often active.

1. How did you get started in trading and on BitMEX?

I bought into bitcoin at the end of 2013, but only started actively trading it a bit over half a year ago. Moved over to BitMEX at the start of March right before the ETF decision since I needed a lag-free place to trade. I only started being a profitable trader after the ETF had blown over.

2. I notice that you did not start with a large amount when you first signed up with BitMEX. Do you think the size of your initial capital matters when you start out?

The initial capital size can change some of the strategies available to you. In general, having less means you can hold your positions open for a smaller time period and still make a good profit. However, it also comes down to how much capital you actually have. Even if the money is something you can afford to lose, as long as the sum is a non-trivial amount it’ll be hard to cut your emotional ties to it. Especially since it’s likely you will lose at least 50% of it before starting to make a consistent profit (I lost pretty much all of mine and had to invest more.) So in my mind, the initial capital is less like an investment and more like a cost for a lesson in trading.

3. What were your motivations to start trading?

Well obviously there’s the money. I was already invested into bitcoin and figured it would be a cool idea to try to double or triple the amount. After passively watching the charts for years I thought I had a handle on bitcoin and could try to predict the price. Gave it a shot and lost quite a bit and then tried to win it all back like a true addict.

4. Why do you like trading on BitMEX?

Initially I picked BitMEX cause of the high leverage allowed and some comments on Reddit. Nowadays I’m not sure what there isn’t to like. High volume, high liquidity, low fees all around, isolated leverage, secure wallet, good customer support, no nazi-mods in the trollbox. You even refunded those liquidations caused by the GDAX downtime and subsequent flash crash out of your own pockets. Plus the UI is nice.

5. What are the key things you look for when placing a trade?

Big moves downward and high volume combined with big long liquidations. Then I just market buy and either dump my position after a small retrace up within minutes or keep buying if the price isn’t going up yet. Usually after many hours of dropping there’s a double bottom combined with a retrace going higher than the previous high. If that happens I try to keep my position open and wait for a good top to sell within the next hour or two.

6. How do you manage your risk?

I start buying small and then increase the position as it goes deeper, but trying to always stay below 5x. I don’t use stops and I only try to sell at a local top. Sometimes it gets pretty sweaty and I have a lot of unrealized losses but usually the trades end up at least breaking even. If things get really bad I might panic sell a bit of my position just to feel better, but I found that’s usually right at the bottom. Barring any black swans, it’s unlikely the price will tank more than 10% in one go without a retrace, and when the retrace happens I just dump it all regardless of losses.

7. What would be your advice to novice traders starting out on BitMEX?

a) Everyone has to find their own way to trade. Whether it’s short-term or long-term, buying or selling. What indicators, risk-levels, and leverage to use. Experimenting with different strategies will help you find your style.

b) You have to know when to be bull-headed and when to eat the loss. I’ve made plenty of bad or questionable trades but got out unscathed by just holding them open. On the other hand, an early stop-loss can save you a lot of headache and minimize the losses, while also allowing you to enter at a better price.

c) Very often the best trade you make is the one you don’t. If you have no clue what the market might do, then you may as well be flipping a coin by entering the market.

d) Any losses you take have to be accepted, and more importantly don’t try to win it all back by taking more risks. Additionally, if you lose a lot and start to tilt, it’s time to take a break.

e) Ignore your emotions. Don’t FOMO, don’t panic sell. There’s always a local top or bottom to enter at if you really want to, but usually it’s better to just sit it out if you missed the run.

f) Don’t gamble with 10x+ leverage.

g) If you really do want to gamble all-in, stick to 25x with a manual panic close if it’s not going your way. (This only works with position sizes up to 25k with XBTUSD though.)

Thanks for your time, truly an inspiration!

Old Folks’ Home

Those who can afford a plane flight are amongst the richest globally. The most avid travellers are the middle aged to geriatric. They have the most disposable income and time.

Private banks cater to the middle aged and elderly because they have the most cash. The advertisements of private banks in airports provide a clear glimpse into which age cohorts bank desire. Usually the advertisement features a elderly couple with young grandchildren. The message is clear: invest for the future. You might be dead, but your progeny deserves the fruits of your labor.

Due to the target market, private banks are conservative and stuffy. Impressive bank edifices subtly suggest a solid, stable, and responsible financial institution. Once accepted into the the high net worth (HNW) members club, you can expect impeccable service and egregious transaction fees.

Your banker / babysitter will present him or herself as the epitome of class and sophistication. The costume jewellery worn: Hermes ties, Louboutin heels, Chanel totes etc., assure you that this person is professional, classy, and can relate to your life experiences.

After handing over your minimum low digit millions of USD to a venerable institution, a plethora of “suitable” investment opportunities are presented to you. Given the age demographic of clients, the search for low risk, greater than inflation yielding assets is the name of the game.

The money printing orgy since 2009 has decimated returns for elderly fixed income investors. The dash for trash in search of yield necessitated buying junk debt at lower and lower yields, and equities at higher and higher P/E ratios. No investors believe the market is undervalued. Investors of all ages and styles are now alternative investors looking for the next uncorrelated hot thing.

Bitcoin and digital currencies in general are finally a tiny fixture of the investment universe. Anything that asset managers can sell to their clients at high fees will be adopted. The question is what is the general perception of the said asset class.

Up until this year, Bitcoin and altcoins were playthings of anarchists and drug users. When the digital currency complex reached $100 billion market cap, they became alternative investments. Private bankers, with a straight face, can push their stuffy, conservative, geriatric clients into digital currency investments. The best part is, because the asset class is so new, yuge fees can be charged.

Falcon Private Bank in Switzerland received the green light to offer a Bitcoin investment product to its clients. Banks want to be a close second. Falcon is under duress due to a loss of its banking license in Singapore relating to the 1MDB scandal. They have nothing to lose in order to repair their damaged brand. Going full crypto in the hopes of differentiating their product offering is prudent at this stage.

Singapore is the Switzerland of Asia. The Monetary Authority of Singapore (MAS) will certainly feel pressure to allow one or more private banks to offer similar products. The MAS has a strong government mandate to make Singapore a FinTech hub globally. A properly sanctioned roadmap to offering Bitcoin and other digital currency products will materialise.

Other FinTech and private banking friendly jurisdictions will adopt similar frameworks to encourage domestic private banks to offer similar products. Investment advice surrounding digital currencies presents a juicy fee pool. Regulators cannot ignore the requests of their member banks for a way to skim more money from their clients. The current traditional product offering is boring and yields little.

As more banks and asset managers become comfortable with wallet security, a trickle, then a flood of money will find a home in crypto. The chain-split / hard fork drama is a minor distraction to traders with a time horizon greater than 6 months. Political, regulatory, and media capital invested in promoting a new asset class portends to a bright future.

Policy on Bitcoin Hard Forks

Anyone can create a chain fork of Bitcoin at any time. The possibility of a User Activated Hard Fork (UAHF) on 1 August 2017 requires that we clarify our position on any and all potential hardforks.

BitMEX Policies

At BitMEX, our top priority is protecting the assets of our customers. In order for us to effectively do this, we insist that any Bitcoin hard fork includes the following:

  • Strong two-way replay protection, enabled by default, such that transactions on each chain are invalid on the other chain.
  • A clean break, such that the new chain cannot be “wiped out” by the original chain.
  • A modification to the block header such that all wallets (including light clients) are required to upgrade to follow the new chain.
  • A minimum of three months of open testing and review, before the client is formally released and a further three months after this, before the fork activates.

Should a hardfork not follow these policies, we will not list the coin and may not allow users to withdraw this coin from BitMEX. To be clear, we do not intend to access or keep these coins. The administrative overhead of distributing any and all hardforked coins (including Bitcoin-based distributions like Byteball/Lumens) is prohibitive and BitMEX will not monitor or maintain balances of hard-forked coins.

Additionally, support of any forked currency is solely at the discretion of BitMEX. While we will snap users’ margin balances at the time of the fork in case we decide to distribute, there is no guarantee that it will be safe, desirable, or practical to do so. If this concerns you, you should withdraw your funds before any given fork and handle the split on your own.

In a future case where a block size increase has supermajority support of the community and is handled responsibly, BitMEX intends to follow said chain and we will communicate with our traders accordingly.

1 August 2017 UAHF BitMEX Policy

The Bitcoin Cash (BCC) proposal is aimed at increasing the blocksize. It is scheduled to take place on 1 August 2017. This change is incompatible with the current Bitcoin ruleset and therefore a new coin may be created, which is to be named “Bitcoin Cash”.

It is our understanding that the UAHF proposal does not include two-way replay protection enabled by default. Should the UAHF occur, BitMEX may be unable to protect the new Bitcoin Cash tokens on behalf of clients.

As such, BitMEX will not support the split or distribution of Bitcoin Cash, nor will BitMEX be liable for any Bitcoin Cash sent to BitMEX. Therefore, it is up to our users to withdraw from BitMEX prior to August 1st if they wish to access Bitcoin Cash tokens or any other hardfork.

BitMEX considers any and all hardforks in this vein as altcoins. The .BXBT and .BXBTJPY indices will remain unchanged and will not include BCC.

Policy on BIP91, BIP148, and a Potential Chain Split

There is potential for the Bitcoin network to split if BIP91 (“Reduced Threshold SegWit MASF”) is not activated before the BIP148 UASF (“Mandatory Activation of SegWit Deployment”) start time of 01 Aug 2017 at 00:00 UTC. The following actions will be taken by BitMEX in the event of a potential network split:


  • If BIP91 locks-in and enters an activation period (336 blocks, approximately 56 hours), starting 4 hours before the potential activation time, BitMEX will require 6 block confirmations before crediting deposits due to the threat of a blockchain reorg as non-segwit blocks will be orphaned. This restriction will be lifted shortly after BIP91 activates, once BitMEX principals have ascertained that the chance of further reorgs is below a safe threshold.
  • If BIP91 does not activate before 31 July 2017 13:00 UTC, deposits and withdrawals will be halted until further notice in anticipation of a possible chain split. A round of withdrawals will be processed that day.
  • If you wish to trade the chain split, this date is also the deadline for deposits.
  • If there is a prolonged chain split and thus there are two or more versions of Bitcoin, once enabled, BitMEX will process withdrawals of the majority and minority chain.
    • In order for coins on either chain to be properly withdrawn, a viable method of avoiding replay attacks must be developed.
      • While there is a risk of a replay attack (transactions on one chain also being valid on another), it will not be possible to process deposits or withdrawals.
    • BitMEX will create a snapshot of user’s margin balances (including unrealised PNL) on 31 July 2017 13:00 UTC. A user’s balance of the minority chain’s coins will be equal to his/her balance at this time.

Contract Settlement and Marking

  • If the Bitcoin network splits, currently-listed futures at the time of the split will settle on the sum of spot exchange-listed versions of Bitcoin.
    • It may not be possible to predict or plan to get reliable pricing data from our current Index exchanges, or they may not list the minor coin(s) at all. In the event of a network split BitMEX reserves the right to move all Bitcoin derivatives to Last Price Protected Marking, until a stable index can be composed.
    • Each chain will be represented by a different index, and the sum will be taken to compose the Mark and Settlement Prices. The indices will be separated as to handle a split whereby not every constituent of the BitMEX Index lists a chain.
      • For example, if “Classic” (pre-BIP148) coins are listed on Bitstamp but not GDAX, the Bitstamp “Classic” price will comprise 100% of that part of the index sum.
  • Contracts listed after the split will settle on one version of Bitcoin, chosen by BitMEX. Only contracts listed pre-split will settle on the sum.
  • After the split, the XBTUSD Perpetual Swap will be timed to switch underlying indices in tandem with a futures contract. Ample notice will be given. Like futures, the new index will reference only one chain.

Bitcoin Basis Volatility

Cash and carry arbitrage is a staple strategy for traders seeking high risk adjusted returns. Because Bitcoin can go to infinity but only fall to zero, speculators at the margin are buyers. Add in 100x leverage, and bullish speculators are willing to pay very high per annum interest rates to go long Bitcoin for short periods of time.

Cash and Carry Step by Step:

  1. Buy $1,000 worth of Bitcoin at $2,000
  2. Sell 1,000 BitMEX futures contracts, e.g. XBTM17, at $2,500
  3. Wait until expiry, and collect $500 of profit

Given the current rally, the BitMEX Bitcoin / USD 30 June 2017 futures contract, XBTM17, has traded at a premium (or a positive basis) for almost the entire length of the contract. Traders who sell futures and buy Bitcoin essentially earn a fixed rate of return until expiry to lend long speculators synthetic USD.

To earn the full premium, you must keep the trade on until expiry. However, while arbitrageurs are making good money from this strategy, they are leaving food on the table.

The above chart plots the hourly annualised premium of XBTM17. It is immediately apparent that the premium itself is very volatile. The premium takes the stairs up, and the elevator down.

For traders already comfortable with cash and carry arbitrage, it is time to add a mean reversion strategy to your toolkit. Below are the relevant statistics for the data sample:

Min: -27.31%
Max: +122.30%
Mean: +17.87%
Median: +8.95%
Stdev: 24.68%

While you can’t pick the lows and highs, in general terms you can put on positive carry trades during times of extreme stress and close out when the premium normalises. That allows you to increase your returns during the contract period.

Recently the XBTM17 premium traded over 100% p.a., then a few days later traded at a discount. Instead of waiting another 20 days until expiry, arbitrageurs actively trading the basis could realise the entire 100% return in under 24 hours.

A simple yet effective strategy is what I call the Stair Step Cash and Carry Arbitrage. Assume that a normal range for the premium for a quarterly contract is 0% to 60% p.a. As the premium rises, at each 10% interval I will sell 10,000 XBTM17 contracts and buy $10,000 worth of Bitcoin. If the premium hits 60%, my expected return on $60,000 should I hold until expiry is 35% p.a.

If the premium falls from 60% to 0%, I will buy back 30,000 XBTM17 contracts and sell $30,000 worth of Bitcoin at every 30% increment. The key point is that at all times I have a portfolio with positive carry, and I benefit from volatility in the premium.

You can get very sophisticated about how you choose your increments and sizing of trades. The more granular your steps, the more profit you can harvest from the volatile premium.

Don’t Get High On Your Own Supply

The DAO’s world record crowdsale was eclipsed one year later by the recent Bancor ICO. Bancor raised close to 400,000 ETH valued at $152 million. ICO mania is upon us and the number of projects raising in excess of $10 million is mind blowing.

The common theme amongst the ICOs is that the tokens are created using the Ethereum protocol. Additionally to subscribe, most ICOs require punters to tender Ether and only Ether.

The killer app so far for Ethereum are ICOs. The rampant FOMO induced greed means that newbies and old hands alike must obtain Ether. They either sell a fiat currency or Bitcoin to obtain the mana from Big Daddy Vitalik.

The rapid price appreciation of Ether is due, in large part, to the demand by speculators to buy ICOs. The price remains high after the ICO ends because most teams to date have not cashed out of their loot.

Most teams will not be able to return to the market again begging for more money if they misallocate their capital. The question for teams is how to protect the value of all the Ether raised. Failure to cash out or properly hedge, could mean a rapid evaporation of the paper wealth they now enjoy.

While they do hold physical ETH, salaries and expenses must be paid in domestic fiat currencies. Ethereum raised $18 million of Bitcoin in 2014, then failed to hedge that and thus to pay expenses was forced to liquidate some holdings at a 50% loss. The development roadmap also was altered due to lack of funds.

The current crop of ICO cool kids witnessed the hardships placed on the Ethereum development team by lack of hedging. At the first sign of Ether weakness, they will rush to the exit. The team who sells first, sells at the best prices. When it is known that ICO teams are cashing out, the stampede and its induced casualties will have everyone singing Hakuna Matata.

If I were an ICO team, I would apply a 50% haircut to the value of any ETH raised. Even if I wanted to sell it, I know I couldn’t because the liquidity would disappear long before I could liquidate my entire stack. All the buyers at the margin bought Ether to invest in the ICO, they won’t be around to catch falling knives during the correction.

Some in the community believe it is irresponsible for development teams to raise such god like sums of money. They protest that a few million dollars worth of crypto should suffice any project. Additionally, if all other teams do yuge ICOs, the liquidity won’t be there when you need to sell even if you raise a “responsible” amount of money. Game theory has thus set in and it is now in your best interest to follow the herd and raise as much as you can, expecting that you will only be able to spend a fraction of that amount.

Pop Goes the Weasel

The Bancor ICO set a new benchmark. The $500 million mark is my mental goal post for the height of insanity and that will be the day that Icarus will burn in the noon day sun. Tezos and or Eos are positioned to meet or eclipse that number.

My second mental goal post is if Ether reaches parity with Bitcoin in terms of market cap. The profit taking at that level could cause the ripple that forces a calamitous unwind of the 2017 ICO bubble.

The correction in Ether and the secondary market prices of ICO tokens, will be disorderly. However, even if you do agree with my views, don’t let your haterade preclude you from making money during this glorious bull market.

Why Don’t Banks Own Bitcoin Exchanges?

Fiat government money is one of the biggest profit centres for banks globally. Even though we are all human, to trade and interact with each other requires the exchange of different coins, paper, and electronic credits. Each one of these transactions benefits banks who move money globally for a fee.

At the most simplistic level, the trading of crypto currencies and or digital tokens is just a standard foreign exchange transaction. If banks love foreign exchange, why then do they have an aversion to Bitcoin and other digital currencies?

A Close Second

Banks claim to care about optics, and say they abhor risk to their reputation. Yet – time and time again they’ve shown that they will gladly launder money for dictators, arms dealers, and drug lords. Why the aversion to conducting standard FX transactions involving digital currencies?

Banks also are not scared of breaking laws – but only so long as every other bank is doing it too. When it comes to a new business line that might be controversial to regulators, it is better to be a close second than the first. If meaningful punishment meted out to the first mover is lacking, the rest of the banks will follow headlong like lemmings.

Too Much Money to Ignore

Digital currency trading on-exchange volumes are too big to ignore. Given the level of fees charged to eager traders and speculators, the leading exchanges post revenue figures that value them in the billions of dollars using standard exchange revenue multiples.

The funny part is that a bank is necessary to operate a fiat to digital currency exchange. The on-ramp into the digital currency space requires the exchange to hold client fiat money with a bank. While the bank makes transaction fees on the movement of fiat, they miss out on the very profitable churn generated by digital currency exchange clients.

Hundreds of millions of dollars in fees will be made this year by the leading exchanges. The board of any bank that banks a digital currency exchange should be ashamed of themselves for not expanding their operations and offering, at a minimum, Bitcoin to fiat exchange services.

Trust a Banker

Throughout history, bankers have been held in low esteem. The handling of money is viewed as unclean, while rentier landholders are given the trappings of aristocracy. However the plebes, patricians, and governments still trust banks with their money.

Bank offices exude confidence, grandeur, and – most importantly – security. Contrast that to a slick and minimal website of a digital currency startup. Their airy San Fran, New York, or London offices don’t produce the same effect on potential customers.

The lack of trust between users and exchanges due to hacks, thefts, and a lack of business acumen is one of the largest reasons people don’t take the first step to acquiring some Bitcoin. Through generations of social conditioning, people believe a bank is the best place to store wealth. If your friendly neighbourhood bank offered the ability to buy, sell, and store Bitcoin directly, trust – and therefore trading volumes – would be much higher.

Figure It Out

Senior bankers appear to be catching on. A Barclays executive recently asked the FCA in London to figure out how a bank can join the party. [CNBC]

A wink and a nod from the appropriate alphabet letter agencies will set off a stampede for banks to open their own exchanges. The next question will be: buy or build?

Banks fail miserably at cyber security. Bitcoin, in many cases, does not require physical proximity to where it is stored in order to steal it. In the long run, the real differentiating feature in the exchange landscape is security. Banks that don’t want to “learn” how to conduct proper cyber security should buy the leading exchanges to whom they currently extend banking services – if they can find a trustworthy one.

The conversation between a bank and exchange will be very simple. Either the bank can buy out the exchange at a very generous multiple, or the bank will close the exchange’s accounts, and make it very difficult for the exchange to obtain an account with another organisation in a particular domicile.

As banks slowly come around to the revenue generating potential that a fiat to digital currency exchange offers, traders will abandon exchanges not explicitly owned by a bank. Banks already have millions of hungry financially repressed customers to whom they can immediately offer digital currency trading. The liquidity will immediately shift to bank-backed exchanges.

The Empire Strikes Back

Exchanges who have fought valiantly through the nuclear winter of 2014 and 2015 may not wish to sell out to the banks they loathe. Exchanges who can tap traditional VC funds or the ICO market should purchase struggling banks.

With a bank and its licenses as cover, existing exchanges can continue to innovate faster than an incumbent large bank.

This Time is Different

Yes, it’s likely we’re in a bubble. While the price of many digital currencies are likely to decline in the short-term, banks are now acutely aware of this new asset class. News stories about legacy banks “thinking” about how to offer digital currency trading to their clients will become more common.

I am extremely confident that by 2H2018 there will be a large storied bank that offers Bitcoin trading and storage to its customers. The stampede of Johnny-come-lately banks into the digital currency exchange space will be exciting to watch.

Here Come The Bankers

Goldman Sachs and Morgan Stanley, after their clients pestered them long enough, recently released two widely read reports on where the Bitcoin price is headed. Even though both banks believe the current rally is a bubble, it is very positive that so many clients demanded research on the cryptocurrency.

If there is that much pent up demand, the next question for executives is whether or not the industry is big enough yet to support one or more full time employees market making and trading Bitcoin and other digital currencies. The following is a thought experiment on the cost benefit analysis for starting a digital currency trading desk for a bulge bracket bank.


Traders Are Expensive

Before a young man or woman begins blowing up your capital, the resources needed to get them started run close to a million dollars alone. Market data feeds like Bloomberg and Reuters can run in the tens of thousands of dollars per month. As an example, while I was an ETF trader at Deutsche Bank, my market data costs were $50,000 per month.

The next and bigger cost center is the number of support staff needed. Compliance, middle office, back office, and IT personnel are needed to help a trader effectively perform his or her duties.

The final and most important asset a trader needs is capital. From the bank’s perspective, this capital has a cost. Investors in investment and commercial banks demand a certain return on equity (ROE) for their investment. Goldman Sachs is the most profitable bank by a country mile, mainly because its management actually has a clue about how to use capital effectively.

Over the past 5 years Goldman averaged an ROE of 10%. I will use this as the benchmark for the following calculations.

The trader himself needs to get paid. Given the risk involved in trading Bitcoin, a bank would assign a mid-career trader to the desk. Assume this person’s annual total compensation is $500,000. For an equities’ banker this might be the MD’s take home pay, but for a good FICC trader it is average.

Trading Bitcoin requires a trading desk to have accounts on the leading Bitcoin exchanges. Exchanges, as we know, get hacked repeatedly. Insurance in the Bitcoin space, for good reason, does not exist. The desk needs to assign a probability of default on the exchange. Using the Bitfinex haircut as an example, let’s assume the yearly probability of default is 35%.


Cost Summary:

Trader Support: $1 million
Trader Pay: $500 thousand
ROE: 10%
Default Risk: 35%

The next consideration is how much capital to allocate to this trading operation. Even if the desk is able to achieve the ROE, making just a few million dollars won’t be worth the hassle. The approval for a Bitcoin trading desk would need to come from the CEO. Lloyd Blankfein doesn’t get out of bed for less than $10 million of profit. Let’s assume that the bank, at a minimum, must be able to deploy $100 million.

Given that 35% of the capital deployed will be spirited away, the returns must be achieved on $65 million. In order to make $1.5 million (Cost) + $10 million (Required ROE), the desk must make 17.70%.

A 17.70% annual return is very achievable. I routinely speak about arbitrage opportunities that yield in excess of 50% per annum. However, you cannot put $65 million into any trades I describe without tremendous market impact.

The trading desk will not have a mandate to just punt Bitcoin or Altcoins. They will search for pricing discrepancies between exchanges, or between spot and its derivative. When massive directional bets are removed as a strategy, it is very hard to put that much size into arbitrage trades.


Not Now, But Soon

With a market cap close to $100 billion, the entire crypto space is worth evaluating for a trading desk. However, the market still cannot support the volume needed for a trading desk to meet its hurdle rate.

When the top 5 most liquid Bitcoin / USD exchanges trade in excess of $1 billion per day on average, then we will see the first bank sponsored Bitcoin trading desks emerge. Given that yesterday $500 million was traded by the top 5 exchanges, we are not far away.

Postmortem: Downtime, July 14, 2017


On July 14, 2017, we suffered a minor downtime as a runaway ZFS snapshot process froze up disk I/O on the trading engine. No data was lost. While the outage was relatively minor and required only a host reboot, we took additional time to re-verify data, clean up ZFS snapshots, and fix the underlying issue.

We apologize for the disruption.

If you are interested in our recent migration to ZFS, please see this post.