In an effort to increase resource efficiency and reduce the likelihood of system overload, we are making a change to how we deliver images (partials) to newly established websocket subscriptions, for certain tables.

For clients working directly with our realtime API, images for new subscriptions to certain tables are now being delivered on an interval of 2.5 seconds. The following tables are affected:

– orderBookL2
– orderBookL2_25
– instrument

API clients can expect a latency of up to 2.5 seconds when subscribing to these tables before receiving a table image (a message with a ‘partial’ action).

This change only affects the first message for newly created subscriptions. Subsequent deltas (messages with an ‘update’, ‘insert’ or ‘delete’ action) will continue to be delivered in realtime and are not subject to an interval.

There are no changes to the schema of the API itself. Only the timing of the initial image is affected.

As a market leader in the crypto trading space, we are constantly looking at ways to improve and innovate new and existing products.

To further strengthen the trading of our XBT/USD products, BitMEX is proud to announce an introduction of Kraken’s XBT/USD price feed into the BitMEX .BXBT Index.

This change will take place on 16 September 2018 at 12:00 UTC on the XBTUSD Perpetual Swap product, new Futures products and on our Option products. Existing XBT/USD futures products that have not settled will remain under the existing index.

New Index Change
.BXBT will change from (0.5 * Bitstamp + 0.5 * Coinbase Pro) to (⅓ * Bitstamp + ⅓ * Coinbase Pro + ⅓ * Kraken).

Products Affected:
– XBTUSD
– XBT7D_D95
– XBT7D_U105
– XBTH19

Old Index Change
A new index, .XBT will be created that will be based on the old .BXBT index: (0.5 * Bitstamp + 0.5 * Coinbase Pro).

This new index will be phased out after the settlement of the affected products (28 Dec 2018 12:00 UTC).

Products Affected:
– XBTU18
– XBTZ18

From 06:53 to 07:03 UTC today, September 3rd, 2018, the service of our websocket API was impaired, which impacted the live data updates on the bitmex.com website as well as clients connected directly to our websocket API.

As part of a scheduled software release on the trading engine, our market data distribution component became saturated with a cascade of updates during the restart process which temporarily prevented downstream data distribution on the websocket API.

We apologise for the disruption.  The root cause has been identified and mitigated in the production environment.  BitMEX engineers have already deployed a fix for the underlying issue to prevent a re-occurrence.  We are also improving a number of alerting mechanisms to enable us to recover from potential issues in a more timely manner.

Bitcoin is now down close to 70% from the $20,000 all time high. The bear market is here. What level is the bottom, and when?

My hunch tells me that similar to the 2015 bear market, the price at which the average miner turns off their ASICs will be the local bottom.

During the last bear market that range was $200 – $250. While the price languished, various high profile miners went under. KnC and Spondoolies were two casualties. Most surprisingly, in March of 2015 the difficulty actually dropped. That was 7 months before the price ticked up, but it illustrates the amount of pain that miners faced.

Now assuming there is no positive catalyst, like an SEC approved ETF to save us, at what price do we bottom? I believe the key consideration will be when miners begin to shut off their machines; and hence the question, what is the marginal cost of a Bitcoin?

A few days ago I chatted with one of the largest mining facility operators globally. He told me that the average electricity cost of Chinese miners all-in is 6 to 7 cents kWh. At that level, he estimated that at a price of roughly $5,000 is when miners would begin altering operations and look to move machines to cheaper areas. At $3,000 to $4,000, these miners would begin to shut off machines completely.

However, these rough anecdotes assume that miners using 7nm chips either do not work efficiently well, or will not be sold until 2019. Bitmain, Dragonmint, and GMO are all racing to build such miners. The firm that successfully brings a 7nm miner to market, will absolutely lower the marginal cost of the average mining farm, and decimate the older generation mining rigs.

Price leads the hashrate and the final confirmation of the breakeven level will be whether difficulty actually drops. That would require a sustained period of price weakness to shutter enough miners for the hashrate to fall.

When in Doubt, IPO

Upside Risks – SEC Approved ETF

It all started in Feb 2017 on a beach in southern Thailand. Thailand’s king passed a few months prior, so the party atmosphere was subdued. Accompanied by a good friend of mine and one of the best shitcoin traders in the game, we headed down the beach in search of a party.

One of his big shitcoin positions at the time was Pepe Cash. This was the precursor to Crypto Kitties. For those not in the know, PepeCash is “rare pepe” memes hashed onto a blockchain. The next killer app to be sure. Pepe Cash was on a mini run, and my boy constantly monitored the market.

We didn’t find a poppin’ party, but we did find special shakes. The bartender didn’t think we were sideways enough so he went in the back to get the real stuff. Over the next few hours we walked for miles, met interesting tourists and locals, and waxed philosophical about shitcoins.

On our ride back to our hotel, I noticed something strange. Our Tuk Tuk driver was wearing a trucker hat with a Pepe the Frog logo on it. Not trusting my eyes, I nudged my friend to confirm what I saw. He concurred that our driver was sporting a Pepe hat. My friend immediately whipped out his phone to check the market. Perhaps they saw what we did. Pepe Cash was pumping and he bought some more.

We both looked at each other and knew it was a sign that something special would happen in 2017. What actually happened was far beyond what we could have ever imagined.

The real profit in 2017 was made by Ether holders, shitcoin projects, and promoters. The seed capital for many of the venerated crypto hedge funds emanated from outsized returns on holdings of Ether and token projects.

Jealous traditional VCs transformed portions of their funds into poorly designed hedge funds so that they too could punt shitcoins. Everyone piled info the same deals, all thinking they “got it”. That worked well all of 2017.

Today, Ether slides towards $200. At best, many token projects are down 50% from 2017. At worst, they are slightly above than zero.

This begs the questions:

1. Did any funds actually realise any of their outstanding 2016 profits?
2. Can VC-turned-hedge-fund-punters psychologically handle mark-to-market losses?
3. How many token projects actually sold a large or hedged portion of the Ether they raised?

Big Door In, Small Door Out

One of the first things you learn as an Asia Pacific trader: how you exit a position is more important than how you enter.

My first trading book was the Vietnam certificates book. Our desk issued USD denominated certificates on a basket of Vietnamese stocks. Calling the Vietnamese stock market “Mickey Mouse” would have been a compliment in 2009.

You could only go one way per trading day on a particular stock. If you bought, you could only continue buying intraday, you could not sell. There was a 5% limit up and down each day; any stock in the news would hit either of those limits immediately in the morning auction. That meant you had to fax your orders into the broker and make sure you got in the queue as early as possible. Unfortunately, sometimes your broker front ran you because they knew you had size to trade in a particular stock.

My boss encouraged me to take a view on the market. Given the structure of the market, if I took a position, I was stuck with it for a while. And when I wished to exit, I would have to sell into strength or buy weakness to get out of a long or short position respectively.

When I became an ETF market maker, I routinely traded other “Mickey Mouse” markets like India, Indonesia, and China just to name a few. These markets were and still are marked by snap decisions (often overnight) by regulators which adversely affect traders who aren’t politically connected. I became obsessed with how to get out of any position: a trait which serves me well in the crypto markets.

My first boss taught me that everything was my fault as the trader. Obviously there are many things outside of your control, but if you approach your profession with that mentality you attempt to quantify and mitigate all of the risks within your control.

The point of my sermon is that most VC investors do not approach their investments with this mentality. Due to the illiquidity of their investments, they can mark to fantasy, show amazing returns on paper, and get paid. The only secondary market validation of their investments is the next round of fundraising, which can easily always go up if you get your boys to go in along with you. You pump my bags, I’ll pump yours.

VC investors loved ICOs in the bull market because they could point to an objective and liquid secondary market valuation. They used these eye-popping returns to raise bigger shitcoin funds in 2017, and early 2018. However, objectivity and transparency is undesirable when your shitcoin portfolio is down by a minimum of 50%. Depending on the vintage of the fund, it might be up, however, most money was raised and invested in 2H2017 to 2H2018. That means the suckers who invested recently are most likely down.

The VC investor who has never suffered the vagaries of the market is as green as the noob who thinks he or she can go from 1 to 100 Bitcoin in a few trading days. They don’t have the mental strength to cut positions to limit further losses, or backup the truck and buy opportune dips even though they are down. More importantly, LPs can now see an objective last price for a particular token, and can’t be hoodwinked. They will attempt to be a Monday morning quarterback, and that only adds to the VC investors’ anxiety. At a certain point, they go “fuck it”, and dump everything they can.

It is this moment, that Ether goes from a 3-digit to a 2-digit shitcoin.

Concentration Risk

Before the SAFT and other private token placement monstrosities, the majority of money was raised from retail token punters. Now that projects are scared of federal pound-me-in-the-ass prison, they mostly only accept accredited investors.

Accredited investors always had a way into new technology projects due to their wealth and access. This pool of investors is also highly concentrated. The number of funds that can spray $1 to $5 million into every vapourware project that agrees with their sector thesis is limited. However, these gatekeepers control a vast ocean of institutional money. Softbank’s Vision Fund is $100 billion.

So instead of a more dispersed pool of investors, the number of token holders of projects raising serious money decreased dramatically starting in mid-2017. The liquidation preferences went from dispersed along a price curve, to very concentrated.

VCs all compete with each other for the same pools of capital. These pools of capital all employ professionals from the same schools, and who passed the same financial certification tests. Therefore they will buy together and sell together. The biggest risk in the money management game is career risk. Better to lose money with everyone else, than lose money alone. The latter will cost you your job. And there ain’t no other profession that pays as well as financial services relative to the skills needed to be a practitioner. I remember one of my besties trying to argue he had skills because he could calculate the NAV of an ETF using the sumproduct() function on his excel sheet. #Delusional.

The herd of token VC punters will all decide to sell at the same time. If you don’t sell, and the market continues falling, you lose your job. So everyone sells simultaneously but who can eat all that shit? Retail cannot because the deals would never have gotten so large without institutional money. So we gap lower, first on tokens, then on the mothership Ether.

I don’t know what that tipping point will be, but in hindsight, it will be obvious when the capitulation occurs. There are those who believe that a sustainable token economy can exist. But they won’t be buying at these levels. Sub-$100 takes us back to Spring 2017 levels. At those depressed prices, the carrion is ripe for ingestion.

One of our strengths at BitMEX is financial innovation. We created the XBTUSD perpetual swap, a truly unique product to any financial market. XBTUSD is now the most liquid crypto instrument globally by a factor of 10 and has been emulated by a half dozen crypto markets.

On the back of that success, BitMEX has created a way to replicate the same Bitcoin-margined perpetual swap but on Ether / USD via a quanto pricing model. This product is the ETHUSD perpetual swap. In just under two weeks, this product has become the most liquid Ether / USD (or USD equivalent) pair globally, and has proven to be a vital instrument in speculating or hedging on the ETH/USD price pair.

In the last 24 hours, BitMEX’s ETHUSD swap has traded the equivalent of 800,000 ETH. The next most liquid ETH/USD and ETH/USDT markets, Bitfinex and Binance, traded just under 500,000 ETH each in the same period.

If you are still unsure on the pricing or trading of this instrument, please take a look back at our newsletter from last week where we run through multiple worked examples on hedging and speculating. To aid in your understanding, we have also created a downloadable spreadsheet to work through the math.

Hedging a quanto perpetual swap is not straightforward. The added component of correlation risk between two crypto assets complicates things. I will take things from first principles, then provide a more general formula.

Assumptions:
Symbol: ETHUSD
Multiplier: 0.000001 XBT
ETHUSD Price: $500
.BETH (ETH/USD Spot Index): $500
.BXBT (XBT/USD Spot Index): $10,000

Scenario 1 – Short ETHUSD and Hedge

You are lifted for 100,000 contracts of ETHUSD.

First let’s compute your currency exposures:

XBT Value = $500 * 0.000001 XBT * -100,000 = -50 XBT
ETH Value = XBT Value / [ .BETH / .BXBT ] = -1,000 ETH

Next you hedge your ETH/USD exposure by purchasing 1,000 ETH at the spot price. Assume you can match the current .BETH Index price on your purchase.

You have hedged your underlying currency exposure. At this point your exposure is perfectly hedged. However, as the price of ETHUSD changes, your PNL on ETHUSD will be in XBT, while the PNL on your ETH hedge will be in USD.

Let’s look at two extreme examples.

Example 1: .BETH Rises and .BXBT Falls

.BETH and ETHUSD rises to $750
.BXBT falls to $5,000

ETHUSD PNL = (ETHUSD Exit Price - ETHUSD Entry Price) * Multiplier * # Contracts = -25 XBT, USD Value -$125,000

ETH Spot USD PNL = (.BETH Exit Price - .BETH Entry Price) * # ETH = $250,000

Net USD PNL = ETHUSD XBT PNL in USD + ETH Spot USD PNL = +$125,000

In this example the correlation between the USD value of XBT and ETH is -1. They moved in a perfectly negatively correlated fashion, and you made money.

Example 2: .BETH Rises and .BXBT Rises

.BETH and ETHUSD rises to $750
.BXBT rises to $15,000

ETHUSD PNL = -25 XBT, USD Value -$375,000
ETH Spot USD PNL = $250,000
Net USD PNL = -$125,000

In this example the correlation between the USD value of XBT and ETH is +1. They moved in a perfectly positively correlated fashion, and you lost money.

The short ETHUSD position + Hedge profited when correlation fell, and lost when the correlation rose. Due to the flat ETHUSD vs. .BETH basis, the entry price assumed a correlation of zero between the two cryptos.

Scenario 2: Long ETHUSD and Hedge

You are hit for 100,000 contracts ofETHUSD.

First let’s compute your currency exposures:

XBT Value = $500 * 0.000001 XBT * 100,000 = 50 XBT
ETH Value = XBT Value / [ .BETH / .BXBT ] = 1,000 ETH

Next you hedge your ETH/USD exposure by shorting 1,000 ETH at the spot price. Assume you can match the current .BETH Index price on your purchase, and there is no cost to borrow ETH for this short sell.

You have hedged your underlying currency exposure. At this point your exposure is perfectly hedged. However, as the price of ETHUSD changes, your PNL on ETHUSD will be in XBT, while the PNL on your ETH hedge will be in USD.

Let’s look at two extreme examples.

Example 1: .BETH Rises and .BXBT Falls

.BETH and ETHUSD rises to $750
.BXBT falls to $5,000

ETHUSD PNL  = 25 XBT, USD Value $125,000
ETH Spot USD PNL = -$250,000
Net USD PNL = -$125,000

In this example the correlation between the USD value of XBT and ETH is -1. They moved in a perfectly negatively correlated fashion, and you lost money.

Example 2: .BETH Rises and .BXBT Rises

.BETH and ETHUSD rises to $750
.BXBT rises to $15,000

ETHUSD PNL = 25 XBT, USD Value $375,000
ETH Spot USD PNL = -$250,000
Net USD PNL = $125,000

In this example the correlation between the USD value of XBT and ETH is +1. They moved in a perfectly positively correlated fashion, and you made money.

The short ETHUSD position + Hedge profited when correlation rose, and lost when the correlation fell. Due to the flat ETHUSD vs. .BETH basis, the entry price assumed a correlation of zero between the two cryptos.

The below table summaries the two scenarios:

Time Horizon

The correlation between XBT and ETH is not static. The longer you hold a hedged swap position, the more chance that the correlation regime you expect based on the recent past, will change.

Unlike a futures contract, the ETHUSD swap has no expiration date. Therefore your quanto risk is specific to your time horizon. For market makers who are in and out quickly, the quanto effect is negligible. For cash and carry market makers who hold a position for an extended period of time to capture funding, the quanto effect can destroy one’s PNL.

Covariance

Many market makers will not be satisfied leaving their correlation risk unhedged. They will constantly hedge their PNL on the BitMEX and spot leg of their portfolio. Depending on the XBT and ETH volatility, and their correlation, the covariance will determine whether the hedging of PNL positively or negatively impacts your overall profits. If both assets are highly volatile and the correlation is moving in or out of your favour, your gains or losses from hedging the PNL are amplified.

We are in uncharted territory. In a few month’s time, I will observe the past data and attempt to calculate what portion of the funding is attributed to market makers pricing in a quanto risk, and what portion is due to the interest rate differentials between ETH and USD.

Speculators care about obtaining exposure to risk. How they get that exposure if they can get in and out cheaply is secondary. If BitMEX is able to create a liquid market for Bitcoin quanto’ed derivatives, speculators will flock to them.

As I previously explained in “Why Quanto?”, in order for BitMEX to offer ETH/USD risk, we had to quanto into Bitcoin. This post will explore the concepts speculators care about.

For all the below examples we will use the following assumptions:

Contract: ETHUSD
Multiplier: 0.000001 XBT per 1 USD
Contracts: 10,000

Contract Value

The most important aspect to a speculator is the contract’s payoff function. Since we are speculating on the ETH/USD price, ideally the contract’s Bitcoin value should increase and decrease in a linear fashion with respect to the ETH/USD price.

I assume the speculator denominates their profit in Bitcoin (XBT) terms. Therefore the value of Bitcoin in USD terms at a particular ETH/USD price is irrelevant. Put simply, the speculator wants to use Bitcoin as a margin to earn more Bitcoin.

The above chart illustrates that at different ETHUSD values, the XBT value of the position changes linearly. That is exactly what the speculator desires.

XBT Value = ETHUSD Price * Multiplier * # Contracts

Calculating Margin

How is the amount of Bitcoin margin calculated? The initial margin for the ETHUSD contract is 2%, or 50x leverage.

Initial Margin (IM) = 2% * XBT Value

If you enter the trade at an ETHUSD Price of $500, this is your initial margin requirement:

IM = 2% * $500 * 0.000001 XBT * 10,000 = 0.10 XBT

The next important consideration is what is your liquidation price. That is determined by the maintenance margin. The maintenance margin for the ETHUSD contract is 1%. If the underlying ETH/USD spot price declines by 1%, you will be liquidated.

Calculating Profit and Loss (PNL)

The PNL is denominated in Bitcoin. In Bitcoin terms, the PNL changes linearly with the ETHUSD price. If the contract goes up 1%, your Bitcoin PNL also goes up 1%. The chart above illustrates that.

XBT PNL = (ETHUSD Exit Price - ETHUSD Entry Price) * Multiplier * # Contracts

In the above example, if the ETHUSD price moves from $500 to $600, this is the XBT PNL:

XBT PNL = ($600 - $500) * 0.000001 XBT * 10,000 = 1 XBT

Number of Contracts

To get a certain amount of Bitcoin exposure requires a little math.

The following describes how to calculate how many contracts it takes to equal a desired Bitcoin notional.

Contracts = XBT Notional / [ ETHUSD Price * Multiplier ]

If you want 100 XBT of risk, how many contracts of ETHUSD must you trade:

Contracts = 100 XBT / [ $500 * 0.000001 XBT ] = 200,000 Contracts

The quanto structure satisfies the desires of a Bitcoin-based speculator. The major components that speculators care about all vary linearly with respect to the ETH/USD price. The relative rich or cheapness of the contract vs. the underlying is not a major concern if the contract is liquid.

The factors that govern whether the contract will be at a premium or discount will be explored in the subsequent piece. These considerations heavily depend on how to hedge a quanto derivative from first principles. The hedging of the contract is where the non-linear effects matter.

The USD is the biggest shitcoin out there. However, all assets are priced against it. Crypto is not immune. The Bitcoin / USD price is the most important cross in the crypto asset universe.

Moving into the altcoin space, the most active crosses are against the USD as well. To replicate our inverse style derivatives on an altcoin / USD cross requires us to accept the altcoin in question as collateral. The next natural altcoin BitMEX could accept is Ether. However, to fit into our multi-sig security process, it requires us to use/code an Ethereum multi-sig smart contract.

Unfortunately, due to various exploits of popular Ethereum multi-sig smart contracts, we never felt comfortable custodying Ether. Rule 1, to infinity minus 1, of operating a crypto trading platform, is don’t lose the crypto. Anything we can do to limit our risk surface area we must do. Therefore, taking Ether as collateral given the current state of the protocol is a non-starter.

Given these constraints, we cannot launch an Ether margined inverse ETHUSD contract. An inverse style contract is one where the margin and PNL currency is denominated in the home currency (ETH), the quote currency is denominated in the foreign currency (USD), and the contract value is a nominal amount of the foreign currency (USD).

Inverse Contract Example: XBTUSD Swap

Margin Currency: XBT (Bitcoin)
Quote Currency: USD
Contract Value: $1

In order to offer risk on ETH/USD where Bitcoin is used as the margin and PNL currency, the quanto derivative type is necessary.

From Wikipedia:

A quanto is a type of derivative in which the underlying is denominated in one currency, but the instrument itself is settled in another currency at some rate. Such products are attractive for speculators and investors who wish to have exposure to a foreign asset, but without the corresponding exchange rate risk.

Quantos are exotic derivatives that can move non-linearly with respect to the underlying. However, they are very beneficial for speculators and hedgers in search of liquidity, where they can post margin in a currency in which they feel comfortable. In my time as a delta one trader, we routinely traded USD quanto derivatives to get exposure to local currency futures contracts in countries that restricted the trading ability of foreigners (e.g. India and Taiwan).

The recently launched BitMEX ETHUSD Perpetual Swap is a quanto derivative. The contract pays out 0.000001 XBT per 1 USD. This means that the Bitcoin multiplier is constant regardless of the nominal USD price of ETH. This is great for speculators, the Bitcoin return varies linearly with respect to the ETHUSD price. For those using this contract to hedge the ETH/USD cross or market makers, it gets a bit trickier. I will get into the mechanics of hedging and market-making later in this newsletter.

Quanto Worked Example Spreadsheet
We have created a spreadsheet for users to download and work through some of the below use cases that can be accessed here.

From 14:29 to 15:26 UTC today, August 4, 2018, access to BitMEX.com and the BitMEX API was severely impaired.

A large spike in load caused an overload in a critical internal system used for rate limiting and sessions, creating a feedback loop in that system where data was recalculated more often then usual, exacerbating the load.

The feedback loop has been fixed and systems have returned back to normal. BitMEX engineers are working to separate these systems entirely, so that these particular non-critical operations cannot affect processing time of critical trade requests and logins.

We apologize for the disruption. BitMEX engineers have disabled the cause of the feedback loop and are working the weekend to separate these critical systems so that such an event cannot occur again.