Update: fix for root cause of last week’s issue

In response to last week’s post, yesterday we successfully released an enhancement to our internal market data distribution component’s re-subscription logic. This addresses the root cause of the previous week’s issue and along with the additional safety mechanism to prevent impact to the trading engine deployed at the time, we don’t anticipate a reoccurrence of last week’s issue.

Tracking US$24 billion Of Tokens ICO Makers Allocated To Themselves

Abstract: This is our third major piece on ICOs. In our first piece in September 2017 we focused on the interrelationships between ICO team members. In our second piece, in October 2018, we tracked the Ethereum balances in the ICO treasury accounts. In collaboration with TokenAnalyst, this piece focuses on the treasury balances of the ICO tokens themselves, on the Ethereum network. This report is based on tokens where the team controlled holding’s were worth an astonishing US$24.2 billion on issuance (in reality liquidity was too low for this value to be realized). Today this figure has fallen to around US$5 billion, with the difference primarily being caused by a fall in the market value of the tokens, alongside US$1.5 billion of transfers away from team address clusters (possibly disposals).

(Source: BitMEX Research)

(Note: A reminder of the various interconnections between ICO team members, from our September 2017 interactive graphic)

Team controlled token holdings (Own tokens) – summary data

US$ billion
Value of ICO coins allocated to token teams 21.5
Issuance to team post ICO 2.7
Total issuance to team controlled wallets
24.2
Coins leaving the team address cluster (Perhaps sales) (1.5)
Profits/(losses) due to token price changes (12.0)
Net impact of Noah (token burn) (4.4)
Net Impact of EOS (1.2)
Current team holdings 5.0

(Source: BitMEX Research, TokenAnalyst, the Ethereum blockchain, Coinmarketcap (for token prices))
(Notes: Price data up to Jan 2019, token data up to Dec 2018, based on data for 108 tokens)

Of the US$24 billion worth of tokens ICO project teams issued to themselves, 54% of the value has been lost due to coin price reductions. The peak valuation of the team holdings of their own tokens, using the individual price peak for each coin, is over US$80 billion. This larger figure implies US$70 billion of “losses” from the peak. Although peak valuation highly is dubious due to a lack of liquidity and most of the tokens were granted to the teams essentially for nothing, therefore classifying these price movements as losses may not be appropriate. Unlike ICO investors, the teams did not have an offering price or initial investment. However, some trading activity occurred at these ridiculously high valuations, therefore we believe it’s still interesting to consider these figures, while bearing these caveats in mind.

Based on current illiquid spot prices, the ICO teams still appear to own around US$5 billion of their own tokens, money they essentially got from nothing, depending on ones view. At the same time the teams may have realized gains of US$1.5 billion by selling tokens, based on coins leaving team address clusters. Although this figure may also be an overestimate, as coins could have left the team address cluster for a variety of reasons.

Data Caveats & weaknesses in calculation methodology

  • The liquidity of many of these tokens is low and therefore the US Dollar values may be gross overestimates, this applies to both the initial allocation, current value and the value of any losses. In some cases, the value of tokens given to the team, for instance with projects such as Veritaseum or Noah, were almost comically large relative to the real trading volume in the coins. Therefore it can be considered unrealistic to value the team holdings based on the exchange price of the tokens.
  • The challenge and uncertainty involved in producing this dataset surrounds the allocation of the tokens to the team address cluster. TokenAnalyst conducted this allocation. The methodology used was imperfect and we have not dug into individual projects. The data was obtained by analysing the token smart contracts and transaction patterns on the Ethereum blockchain and applying machine learning type techniques to establish a team controlled address cluster for the team of each project. The data is therefore a probabilistic estimate and is likely to be inaccurate at the individual project level. However, the primary motivation for this report was to produce macro data about the team holdings of ICO tokens on Ethereum. Although this analysis has produced results which are far from perfect, we believe one can draw reasonable macro conclusions from the analysis.
  • As mentioned above, our analysis is based on reviewing smart contract data and transaction patterns, not documents and policies of individual projects. Therefore, it’s possible we included tokens as part of a team balance, although in reality they are held as part of another form of reserves, escrow or some other category, where it’s inaccurate to attribute the coins to the team’s own funds.
  • The data assumes the issuance date is the same date as when the first price data appeared on Coinmarketcap, this may not be a reliable assumption.

Summary data

Value of coins issued to team controlled address clusters (own tokens) – US$ million – Top 10

(Source: BitMEX Research, TokenAnalyst, the Ethereum blockchain, Coinmarketcap (for token prices))
(Notes: Token data up to Dec 2018, data based on prices at the time(s) of issuance)

Loss in value of team controlled holding (own tokens) – US$ million – Top 10

(Source: BitMEX Research, TokenAnalyst, the Ethereum blockchain, Coinmarketcap (for token prices))
(Notes: Price data up to Jan 2019, token data up to Dec 2018)

Proportional loss in value of coins in team controlled address clusters (own tokens) – Top 10

(Source: BitMEX Research, TokenAnalyst, the Ethereum blockchain, Coinmarketcap (for token prices))
(Notes: Price data up to Jan 2019, token data up to Dec 2018)

Value of coins transferred out of team controlled address clusters (Own tokens) – US$ million – Top 10

(Source: BitMEX Research, TokenAnalyst, the Ethereum blockchain, Coinmarketcap (for token prices))
(Notes: Price data up to Jan 2019, token data up to Dec 2018. Huobi and Qash are exchanges and the tokens appear to have been sent to their respective platforms. It is possible the above figures represents sales/”cashing out”, although there could be other reasons for the transfers)

Current value of coins in team controlled address clusters (Own tokens) – US$ million – Top 10

(Source: BitMEX Research, TokenAnalyst, the Ethereum blockchain, Coinmarketcap (for token prices))
(Notes: Price data up to Jan 2019, token data up to Dec 2018)

The raw data – Team holdings of own tokens – US$ million

Token Value at ICO Post ICO issuance Transfers away from team cluster Loss in value Current value
VERI 4,762 0 (15) (3,196) 1,552
NOAH 4,478 0 (4,423) 55
KIN 980 0 (0) (703) 277
AGI 863 0 (27) (814) 22
POLY 842 0 (17) (727) 99
HT 643 0 (366) (29) 248
GNO 636 0 0 (533) 103
QASH 617 0 (177) (300) 140
MKR 596 0 (46) (445) 105
TEL 452 0 (8) (408) 36
ITC 334 0 (7) (323) 4
ZRX 333 0 (9) (155) 169
ZIP 266 0 0 (226) 41
BLZ 256 0 (32) (207) 17
GTO 241 0 (67) (157) 17
BNB 219 110 0 118 447
BTO 198 0 (28) (165) 5
ICX 160 0 (79) (67) 14
ETHOS 153 0 (15) (123) 16
TNT 152 0 (10) (133) 9
CENNZ 143 0 (6) (121) 15
AST 141 0 (24) (104) 13
KEY 132 0 (2) (124) 6
BIX 118 2 0 (85) 35
CVC 117 0 (1) (75) 41
FSN 100 0 (6) (75) 19
OCN 100 0 (31) (64) 5
DEW 95 0 (1) (87) 7
SRN 89 0 (15) (69) 4
MDS 88 0 (8) (75) 5
EDO 83 0 (11) (58) 15
ABT 76 0 0 (71) 5
WTC 69 0 (50) 17 37
INS 68 0 0 (66) 2
PPT 65 0 (55) (5) 5
IHT 65 0 (2) (58) 5
CPT 65 0 (0) (43) 21
SPHTX 64 0 0 (60) 4
DRGN 58 0 (47) (2) 8
MCO 54 0 (89) 72 37
XYO 54 0 (6) (23) 25
RCN 54 0 0 (48) 6
DPY 47 0 (23) (22) 2
THETA 45 0 0 (30) 16
MANA 41 0 (95) 127 73
R 40 0 0 35 75
APPC 35 0 (24) (9) 2
CMT 33 0 (1) (25) 8
FUEL 32 2 0 (29) 5
CREDO 31 0 (0) (6) 25
DMT 31 0 (17) (12) 2
POWR 30 166 0 (154) 42
LRC 30 8 0 (21) 17
WPR 26 0 0 (24) 2
AMB 24 0 0 (17) 7
RNT 22 0 (1) (15) 7
ENG 22 0 0 (12) 10
COB 22 0 (10) (5) 7
GTC 20 126 0 (141) 6
REN 19 0 (3) (13) 3
DENT 19 635 0 (564) 90
UTT 19 0 (0) (11) 8
AE 13 0 (19) 6 0
DATA 11 0 (3) (6) 3
BRD 10 17 0 (21) 7
SNGLS 8 0 0 (3) 6
LEND 6 0 (7) 3 2
RLC 6 0 (5) 2 3
PLR 6 3 0 (4) 5
HVN 5 0 (5) 0 1
CVT 5 11 0 (8) 9
LYM 5 0 (4) 0 2
SAN 5 0 (7) 5 4
GNT 4 0 (12) 31 23
KICK 3 2 0 (4) 1
DGD 2 0 (5) 5 3
EDG 2 0 (29) 28 1
ENJ 2 0 (0) 1 2
RHOC 1 14 0 (13) 1
ARN 0 6 0 (6) 1
ELF 0 45 0 (40) 6
PAY 0 142 0 (132) 11
DAI 0 1 0 0 1
HPB 0 134 0 (119) 15
CRPT 0 3 0 (2) 1
HOT 0 7 0 0 7
SALT 0 95 0 (92) 3
NAS 0 71 0 (50) 21
NGC 0 12 0 (11) 1
CPC 0 12 0 (9) 3
GVT 0 3 0 (2) 2
SNM 0 14 0 (11) 2
BTM 0 9 0 (1) 8
QRL 0 7 0 (6) 2
NULS 0 71 0 (52) 19
POE 0 58 0 (54) 4
TEN 0 29 0 (15) 13
MTL 0 188 0 (177) 11
WINGS 0 18 0 (15) 3
SPANK 0 106 0 (93) 13
OMG 0 195 0 (154) 41
STORJ 0 133 0 (85) 48
BAT 0 38 0 14 52
VIBE 0 10 0 (8) 2
IOST 0 218 0 (185) 34
Total 21,513 2,723 (14,805) (4,396) 5,035

(Source: BitMEX Research, TokenAnalyst, the Ethereum blockchain, Coinmarketcap (for token prices))
(Notes: Price data up to Jan 2019, token data up to Dec 2018)

Conclusion & summary data

This analysis highlights the lack of standards and transparency in the ICO market, especially when it comes to the allocation of tokens to the founding team’s wallet. Teams were often able to mint, burn, buy, and sell (their own) tokens at will, without analysts being able to easily track what is occurring. We would often see tokens in exchange clusters, and it was hard to tell whether the token project “paid” the exchange to list tokens or the token project just transferred their treasury to the exchange to cash out.

To be fair, perhaps we could improve the analysis by spending more time reading the specific documentation of the individual projects and by speaking to the teams involved. This would have resulted in a more robust dataset.

But one thing about ICOs that many people often overlook, is that ICO teams often make profits in two ways from the issuance:

  1. Selling the newly issued tokens (often for Ethereum), and,
  2. Issuing themselves their own tokens.

Our October 2018 report focused on the former, while this report focuses on the latter. The summary table below combines the figures from both of our reports.

ICO team profits US$ billion
ICO process
Ethereum Raised 5.4
Own tokens issued to founding teams 24.2
Total raised 29.6
Changes in coin price
Ethereum profits/(losses) – Mostly realised 0.8
Own token profits/(losses) – Mostly unrealised (17.6)
Total profits/(losses) post issuance (16.8)
Total ICO team profits 12.8

(Source: BitMEX Research, TokenAnalyst, the Ethereum blockchain, Coinmarketcap (for token prices))
(Notes: Ethereum price data to October 2018, Own token price data to January 2019)

Although, as we have repeatedly explained, there are many inaccuracies and assumptions involved in producing the data. Based on our methodology, it appears as if ICO teams have profited by almost US$13 billion from this ICO process. In our view, this money was made incredibly easily, with very little work, accountability or transparency. Therefore, ICOs have proven to be an extremely attractive way for project founders to raise funds. The results for investors of course, have not been as attractive.

The ICO cycle now appears to be dying down to some extent and it’s much harder to raise funds than it was in late 2017. But with so much money made and lost, the events of 2017 and early 2018 are not likely to be quickly forgotten. Entrepreneurs will remember the success (and keep trying to raise money) while investors will remember the pain. A repeat of this cycle within a few years is therefore less likely than many may think.

Two unrelated minor outages on 9 January

On 9 January BitMEX experienced two unrelated minor outages.

At 02:44:10 UTC the WebSocket API saw a degradation in performance for a minute where 7% of commands sent by clients failed. Connections continued undergoing a 1% failure rate of commands until servers recovered at 02:47:00 UTC.

Clients may have also seen an increase in response times for some market data REST endpoints up during this period. This was due to a rolling restart of the API servers that occurred in too tight of a timeframe.  

In addition, at 05:48:10 UTC and 06:10:10 UTC, BitMEX experienced minor outages for approximately 30 seconds whereby requests to the trading engine were load-shed as the engine was busy. During these times, clients would have observed a lack of updates over the WebSocket API for the same reason. The outages were due to data replay complications during a regularly scheduled market data distribution component restart.  

There was no data loss during these events and an additional safety mechanism to prevent a similar situation from impacting the trading engine has already been deployed. The root causes have also been identified and we are currently working on permanent fixes to prevent a recurrence. Updates will follow in the future.

We apologise for the inconvenience. If you have any questions, please contact customer support.

Atomic Swaps and Distributed Exchanges: The Inadvertent Call Option

Abstract: In this piece, we look at a common problem facing both distributed exchanges and cross-chain atomic swaps: what we call the “inadvertent call option.” Non-custodial fully-distributed trading systems often inadvertently create an American-style call option, rather than the more simple desired operation of exchanging one asset for another. We review how this same issue applies to some specific distributed trading platforms like Bisq and particular cross-chain atomic swaps constructions. We then look at how IDEX solves this problem, but then requires users to trust the platform operator, to some extent, by removing some benefits of distributed exchanges. We conclude that despite the added complexity, in some circumstances it may be better to embrace the call option feature as a viable product, rather than ignoring or fighting it.

Overview

Alongside distributed stablecoins, distributed exchanges (DEXs) are often seen as one of the two holy grails within the cryptocurrency ecosystem. However, similar to distributed stablecoins, the challenges involved in DEXs are often underestimated. In this piece, we focus on one specific challenge with distributed exchange systems: instead of allowing simple exchange, these systems often inadvertently produce American-style call options.

The Theory Of The Inadvertent Call Option

When trading one cryptocurrency asset for another in any fully non-custodial system, one party must act first and the second party must follow. In theory, at some point, this second party then has optionality: – he or she can either follow through and complete the trade, or take no action and stop the trade. In the time interval between the first party taking the necessary action and the second party being required to act, if the price of the token the second actor is attempting to buy falls in value, or the price of the token he is selling increases in value, he could refuse to complete the trade. This means the following:

  1. The trader who acts first has written an American call option on the spread between the two assets.
  2. The trader who acts second has purchased an American call option on the spread between the two assets.

These exchanges can either happen atomically or as two separate transfers. Let’s consider Alice buying Bitcoin from Bob, using Litecoin.

Description Call option problem
Atomic trading

Either both the Litecoin transaction and Bitcoin transaction occur, or both transactions fail

(e.g. Cross-chain atomic swaps).

One party must act first and then the second party can decide to execute both trades or not. This decision can be influenced by price changes in any of the two assets in the intervening period. This provides the second party to act with optionality.
Non-atomic trading

It is possible for one of the transactions in the trade to succeed and the other to fail. In this case, typically a quasi-custodial mechanism such as multi-signature escrow, is required to prevent cheating for at least one side of the trade

(e.g. Bisq-type platforms).

One party must act first and then the second party can decide to execute his part of the transfer or not. Failing to execute the second transfer could result in either:

  • The second party successfully stealing funds from the first party
  • The third party escrow agent reversing the first transaction

Either way, the second party has optionality.

As the table above illustrates, whether the trading is atomic or not, the same optionality principle applies.

One may think this is an insignificant issue, as the time periods can be short or the option value may be low; however, this is typically not the case: the option period is often around 24 hours and cryptocurrency prices can be very volatile. This high volatility is typically the reason traders wish to exchange the tokens in the first place. Therefore, the option value can be significant and impact trading.

It may be possible to mitigate or solve this problem by using more steps involving more deposits, but we have not yet observed a system achieving this. The other way to mitigate the problem is via the reputation of individual traders and a distributed web of trust-based systems, with traders revealing a form of identity. Traders can then lose reputation if they cancel trades based on price volatility. However, this may greatly increase the complexity of the systems, as functioning sybil attack resistant distributed reputation systems are also challenging to construct.

Below we examine three differently constructed distributed exchange type systems (or quasi DEXs) and explain how the call option problem arises.

Case Studies

Bisq

Summary table

Type Non-atomic
Optionality period 24 hours (up to 8 days)
Escrow Multisignature escrow for the trader selling Bitcoin only

Bisq (previously known as Bitsquare) is a peer-to-peer application, which enables one to buy and sell cryptocurrency with fiat money, as well as trade between crypto-tokens. Bisq is essentially a DEX, as traders connect to each other over a peer-to-peer network and transact with each other directly.

Bisq Daily Trading Volume (USD)

(Source: Coinmarketcap)

Screenshot from the Bisq platform

(Source: BitMEX Research)

Below we explain some examples of potential trading activity on Bisq and describe the resulting options.

Example 1: Acquiring Bitcoin with USD on Bisq

Alice wishes to purchase 1 BTC from Bob, using U.S. dollars:

  • Step 1: Bob places 1 BTC in a 2 of 3 multisignature account. The three signatures belong to Bob, Alice, and a third-party arbitrator. This is Bob’s offer, which includes a price (e.g. US$3,800 per BTC).
  • Step 2 – Alice can accept Bob’s offer by paying a small refundable deposit into another multisignature account. The fee is set by Bob (e.g. 0.01 BTC).
  • Step 3 – Alice has 24 hours to conduct a bank wire transfer, paying US$3,800 into Bob’s account. If there is no dispute and the wire transfer occurs, Alice receives the 1 BTC and her deposit back. If no wire transfer occurs, Alice loses the deposit and the 1 BTC is returned back to Bob. Any dispute is mediated by the third-party arbitrator.

The above represents Alice buying Bitcoin; however, when considering the economic incentives involved, since Alice can back out of the trade with limited consequences, one could consider that, after step 2, she has acquired the following American-style call option:

Call option details
  • Underlying: Bitcoin
  • Quantity: 1
  • Strike: $3,800
  • Time to expiry: 24 hours
  • Premium: 0.01 BTC

Therefore, when Bob determines the value of the deposit Alice is required to pay, in theory he should consider Bitcoin’s volatility and use options pricing systems to ensure Alice is unable to acquire the option for a cheap price. Based on the prices currently available on Bisq, it appears many of these options are undervalued.

Example 2: Acquiring Bitcoin with Monero on Bisq

Alice wishes to purchase 1 BTC from Bob, using Monero (XMR):

  • Step 1 – Bob places 1 BTC in a 2 of 3 multisignature account. The three signatures belong to Bob, Alice, and an arbitrator. This is Bob’s offer, which includes a price (e.g. 80 XMR per BTC).
  • Step 2 – Alice  can accept Bob’s offer by paying a small refundable deposit and a fee set by Bob (e.g. 0.01 BTC).
  • Step 3 – Alice has 24 hours to do an on-chain Monero transfer. If there is no dispute and the transfer occurs, Alice receives the 1 BTC and her deposit back. If no wire transfer occurs, Alice loses the deposit and the 1 BTC is returned back to Bob. Any dispute is mediated by the arbitrator.

Again, the above example may be considered as Alice buying Bitcoin; however, when considering the incentives, since Alice can back out of the trade with limited consequences, one could consider that she has acquired the following American-style call option:

Call option details
  • Underlying: Bitcoin
  • Quantity: 1
  • Strike: 80 XMR
  • Time to expiry: 24 hours
  • Premium: 0.01 BTC

If one is trying to capture the benefits of buying a call option with a low premium, this Monero trade may be more beneficial than the U.S. dollar version, since the Monero price is more volatile, and therefore the value of the option is higher. Since the Monero price is more volatile than Bitcoin, it may be more economically correct to conclude that Alice has acquired the following put option, rather than a call option.

Put option details
  • Underlying: Monero
  • Quantity: 80
  • Strike: 0.013 BTC
  • Time to expiry: 24 hours
  • Premium: 0.01 BTC

As a trader, if one wants to take advantage of this structure, one could purchase these Monero puts for a low premium and then hedge the exposure by going long Monero on a centralised platform. However, Bisq has small position limits and therefore the size of the profit-making opportunity is limited.

Although it may make marketing the platform more challenging, it might make Bisq more robust to rebrand these trades as options and encourage sellers of Bitcoin to set the deposit price such that it’s consistent with the premium payment for the equivalent option based on the price volatility of the assets involved, for example by using the Black–Scholes model.

Cross-Chain Atomic Swaps

Summary table

Type Atomic
Optionality period 24 hours (or whatever the parties set as the lock time period)
Escrow None

We believe cross-chain atomic swaps were first described by TierNolan on the Bitcointalk forum in May 2013. Cross-chain atomic swaps allow users to exchange one asset for another atomically, such that the entire process either succeeds or fails. This allows for no risk for either party losing out by only one of the two transfers completing.

The following illustration describes the on-chain atomic swap process.  It is based on a swap between Alice and Bob, with Alice exchanging 1 Bitcoin for 100 Litecoin belonging to Bob.

Cross-chain Atomic Swap Construction

# Actor Description
1 Alice Alice picks a random number X.
2 Alice Alice creates a transaction sending 1 BTC to Bob.

Transaction 1

The transaction can be redeemed when either:

  1. Bob signs it and X is known, such that the hash of X is a necessary value.
  2. Both Alice and Bob sign it.
3 Alice Alice creates and signs a transaction sending the 1 BTC output of transaction 1, back to herself.

Transaction 2

The transaction is time locked for 24 hours.

4 Alice Alice sends transaction 2 to Bob.
5 Bob Bob signs transaction 2 and returns it to Alice.
6 Alice Transaction 1 is broadcast to the Bitcoin network.

7 Bob Bob creates a Litecoin transaction sending 100 LTC to Alice.

Transaction 3

The transaction can be redeemed when either:

  1. Alice signs it and X is revealed, such that the hash of X is the necessary value.
  2. Both Alice and Bob sign it.
8 Bob Bob creates and signs a transaction, sending the 100 LTC output of transaction 3 back to himself.

Transaction 4

The transaction is time locked for 24 hours.

9 Bob Bob sends transaction 4 to Alice.
10 Alice Alice signs transaction 4 and returns it to Bob.
11 Bob Transaction 3 is broadcast to the Litecoin network.


At this point, Alice has the optionality.
If the LTC/BTC price ratio increases, she could continue the swap process. Or, if the LTC/BTC price ratio falls, Alice can end the process here.

Call option details
  • Underlying: Litecoin
  • Quantity: 100
  • Strike: 0.01 BTC
  • Time to expiry: 24 hours
  • Premium: 0
  • Type: American
12 Alice Alice spends the output of transaction 3 to herself, revealing X. Alice now has 100 LTC.

13 Bob Bob spends the output of transaction 1 to himself, using the X Alice provided above. Bob now has 1 BTC.

(Source: BitMEX Research)

As the table illustrates, although one is attempting to structure an atomic swap, similar to Bisq, it has inadvertently resulted in an American-style call option. The same issue appears to apply to either multi-currency routing via the lightning network or off-chain lightning-based cross-chain atomic swaps, during the construction of the channels. It could be possible to solve these issues with more steps and a longer series of deposits, although this added complexity may make implementation more challenging. Just as for Bisq above, it may be more appropriate for cross-chain atomic swap developers to embrace the call options and make it the product, rather than to try to brush this problem under the carpet or solve it with added complexity.

IDEX

Summary table

Type Atomic
Optionality period n/a
Escrow Partial escrow for both sides of the trade with IDEX, with a sunset clause

IDEX is an exchange platform using the Ethereum network. Traders deposit funds into an Ethereum smart contract, where the signature of both the traders and the IDEX platform is required to submit orders, execute trades, or make payments.

After a certain time horizon, users can withdraw funds from the smart contract without a signature from IDEX, which protects user deposits in the event that IDEX disappears. Order submission, order cancellation, and order matching is conducted off-chain on the IDEX servers, to allow for a fast and seamless user experience. The events are then submitted in sequence to the Ethereum blockchain and are only valid with a valid signature from the users. Therefore, IDEX is unable to steal user funds or conduct trades without user authorisation.

According to Dex.Watch, IDEX is the global number one Ethereum-based DEX, with an approximate market share of 50%. IDEX-type platforms are in many ways more advanced than the exchanges above as they can solve the call option problem by having both party’s funds partially held in escrow during the trading period.

IDEX Daily Trading Volume ( USD)

(Source: Coinmarketcap.com)

Although IDEX cannot steal user funds or conduct trades without authorisation, the order of events is determined centrally by IDEX. IDEX could fail to execute an order in a timely manner as well as front run orders or fail to execute an order cancellation in a timely manner. Therefore, while users are protected from some risks common in centralised exchanges, in practise they are still exposed to many of the risks most often talked about with respect to typical centralised exchanges. However, we still consider IDEX type platforms to potentially be a significant improvement compared to the fully centralised alternatives.  IDEX also has other limitations such as one can only trade Ethereum-based assets and the platform is eventually constrained by Ethereum network capacity.

Conclusion

In some ways Bisq’s model is more ambitious than IDEX and cross-chain atomic swaps. IDEX limits itself to tokens that exist on the Ethereum network while atomic swaps only deal with some cryptocurrencies. In contrast, Bisq attempts to handle fiat currencies such as the U.S. dollar. While solving the call option problem may be possible using Ethereum smart contracts or more complex lightning network constructions when, fiat currency is involved, it may be impossible to solve.

Of course atomic swaps and an IDEX type platform could work with US dollars if there is a working distributed U.S. dollar stablecoin. This illustrates how the two holy grails, distributed stablecoins and distributed exchanges, are interrelated. In a catch-22 type situation, each can only function robustly if the other exists.

Without a distributed stablecoin, in our view, when trading fiat currency for cryptocurrency through distributed systems, the use of call options could be inevitable. Bisq is potentially a useful distributed onramp into the cryptocurrency ecosystem; however, rather than trying to solve the call option problem, perhaps Bisq should embrace it. Maybe an effective onramp into the cryptocurrency ecosystem could be via American-style call options. While this may not be easy, it may be the only way to structure a robust highly censorship-resistant way in.

 

Two sides of the coin: the bifurcated near-future of money

 

A digital society requires digital cash. You hear the word cryptocurrency a lot. But there’s a very big difference between a truly decentralised cryptocurrency like Bitcoin and what could be called centralised ‘e-money.’

As Bitcoin today officially heads into its second decade of existence, this is a ripe moment to familiarise yourself with some of the fundamental changes in modern money, including the ways people store and transmit value, that I think you can expect to see in the near future

We Gave Them an Inch, Now They’re About to Take a Mile

The first type of new money I believe we’re going to see is centralised e-money. This descends directly from the current system, taking government (fiat) currency and updating it for the digital age. It’s a natural — and I imagine inevitable — synthesis of the existing central bank system and our increasingly corporatised economy.

The keystone phenomenon that makes e-money possible is the way in which we as a society have grown accustomed to handing over our entire private lives to corporations. We’ve done so in exchange for entertainment and convenience, and we’ve certainly received ample supplies of both. It’s only a small step now, however, to our accepting (or being forced to accept) the corporate issuance of money and the further diminution of privacy that comes with that.

The clearest glimpse into where e-money is heading is probably WeChat Pay, which has now practically eradicated cash in China. The WeChat Pay system works like this: using QR codes and mobile phones, merchants deduct credits from your WeChat wallet, which is connected directly to your bank account. Instantly, while standing at a market stall, Chinese renminbi (CNY) is debited from your account, and credited to the merchant’s account. They get their money, you take your dumplings, and the friction and annoyance of using physical cash evaporates.

As someone who travels around China frequently, I actually love WeChat Pay. However, as someone who built a career in banking and now makes his living in Bitcoin, I also know the privacy limitations of centralised payment systems.

The various mobile payment systems now offered by major players in different parts of the world differ in their details. But in some cases, they know almost everything about you: what goods and services you purchase, as well as where and when you purchase them, which can presumably be linked to all the other data they have on you.

At the same time, we’ve seen our governments in the West, when the spirit moves them, lean hard on our corporate friends to cough up our personal information. Unsurprisingly, the corporations tend to comply with these requests. We have also witnessed private sector payment networks and crowdfunding platforms kick people out for having too close an association with offending ideas or speech, or for being bad actors. Not all of this is necessarily unreasonable, but who gets to draw the line? They do.

Furthermore, monetarily, you can see where this leads: whether it happens gradually or suddenly, at some point central banks and governments, in accord with their nature, may start directing the monetary functions of corporations in a more hands-on way. The way they would do it, I expect, is by deputising commercial banks and large social media companies, who shall become nodes on a payment network, with the authority to participate in the e-money system and earn transaction fees.

Significantly, the payment network’s rules can be enforced instantly and flawlessly via code. The only place left in the system for inefficient or corruptible humans to participate will be at the apex of the network, where the authorities can issue credit directly to people, tax every transaction immediately, and determine who can and can’t be part of the network. In theory, your entire financial existence can be governed this way.

Thankfully, That’s Where Bitcoin Enters the Conversation

Although such a monetary system as I’ve just described may or may not be warehoused on a blockchain look-alike, make no mistake: it is centralised, top-down, and censored (meaning you can be barred from using it if you fall afoul of the centralised powers).

Bitcoin, by contrast, is decentralised, peer-to-peer, and censorship resistant. Bitcoin runs via a network of voluntary, independent, and self-interested actors, who neither demand nor require any favours or permissions; a few basis points in transaction fees is literally all they want from anyone — and all they’re allowed to take. And while the public address of any Bitcoin wallet, and its transaction history, are visible to all, no personally identifiable information is contained in any transaction.

Which means that Bitcoin, or something like it, is perhaps society’s best hope for a private form of electronic money. And privacy, I argue, is an important part of a well-functioning society. For moral and even psychological reasons, citizens deserve the ability to keep certain details about their lives to themselves.

To sum up: for a long time, physical cash has been the best form of money with respect to privacy. But armed with a more efficient and transparent form of e-money, government after government will gradually make physical cash obsolete. Sooner than you think, cash will not be an option for privacy, or for anything else. And private citizens will come to appreciate the inherent value of Bitcoin, as their ability to discreetly hold and transfer value evaporates once cash goes the way of the dodo.

Grounds for Optimism in General

Bitcoin is still very much an experiment. However, after 10 years of operation, the Bitcoin protocol has not been hacked — despite offering what’s effectively the biggest ‘bug bounty’ in software history. Bitcoin is an amazing achievement of disparate private individuals working together towards a common goal.

As I consider how a community of people collectively created an alternate monetary system, I am greatly optimistic about what other aspects of our global society we can improve through a collective, decentralised effort.

And I say this even in the face of the various centralising forces currently being marshalled: humanity’s bifurcated monetary future will be better than our monopoly monetary past, as some money becomes more convenient while other money becomes far more private.

Would Bitcoin’s mass adoption fundamentally transform the financial system?

Abstract

We look at common misconceptions with respect to how banks make loans and the implications this has on the ability of banks to expand the level of credit in the economy. We analyse the inherent properties of money which ensure that this is the case. We then consider why Bitcoin might have some unique combinations of characteristics, compared to traditional forms of money, namely the ability to transact electronically and avoid a third party financial intermediary, thereby avoiding the need for bank deposits, which fuel the credit cycle. We explain the implications this could have on the ability of banks to engage in credit expansion.

 

Click here to download the pdf version of this report

 

Dynamics of Credit Expansion

The core characteristic of the traditional banking system and modern economies, is the ability of the large deposit taking institutions (banks) to expand the level of credit (debt) in the economy, without necessarily needing to finance this expansion with reserves.

An often poorly understood point in finance, is the belief that banks require reserves, liquidity or “cash”, in order to make new loans. After-all where do banks get the money from? It is true that smaller banks and some financial institutions do need to find sources of finance to make new loans. However, in general, this is not the case for the main deposit taking institutions within an economy.

If a main deposit taking institution, makes a new loan to one of their customers, in a sense this automatically creates a new deposit, such that no financing is required. This is because the customer, or whoever sold the item the loan customer purchased with the loan, puts the money back on deposit at the bank. Therefore the bank never needed any money at all. Indeed there is nothing else people can do, the deposits are “trapped” inside the banking system, unless they are withdrawn in the form of physical notes and coins, which rarely happens nowadays.

Please consider the following simplified example:

  1. A large bank, JP Morgan, provides a mortgage loan to a customer, who is buying their first home, for $500,000
  2. JP Morgan writes a check to the mortgage customer for $500,000
  3. The mortgage customer deposits the check into his deposit account, at JP Morgan
  4. The mortgage customer writes a new check, for $500,000 and he hands it over to the seller of the property
  5. The seller is also a banking client of JP Morgan and as soon as she receives the check, she deposits it into her JP Morgan bank account

 

Illustrative diagram of a new home mortgage with one dominant bank in the economy

As one can see, the above process had no impact on the bank’s liquidity or reserves, the bank never had to spend any “cash” at any point in the above example. Of course, the seller of the property does not necessarily have to have an account with the same bank as the one which provided the loan. However large deposit taking institutions, such as JP Morgan, HSBC or Bank of America, have large market shares in the deposit taking business, in their local markets. Therefore, on average, these large banks expect more than their fair share of new loans to end up on deposit at their own bank. Actually, on average, new loans in the economy increases the available liquidity for these large banks, rather than decreasing it.

The accounting treatment of this mortgage, for the bank, is as follows:

  • Debit: Loan (asset): $500,000
  • Credit: Deposit (liability): $500,000

The bank has therefore increased its assets and liabilities, resulting in balance sheet expansion. Although from the point of view of the home seller, she has $500,000 of cash. The above transaction has increased the amount of loans and deposits in the economy. From the customer’s point of view, these deposits are seen as “cash”. In a sense, new money has been created from nothing, apart from perhaps the asset, which in this case is the property. In the above scenario, M0 or base money, the total value of physical notes and coins in the economy, as well as money on deposit at the central bank, remains unchanged. M1, which includes both M0 and money on deposit in bank accounts, has increased by $500,000. Although the precise definition of M1 varies by region.

Cash reserves from the point of view of a bank are physical notes and coins, as well as money on deposit at the central bank. The ratio between the level of deposits a bank can have and its reserves, is called the “reserve requirement”. This form of regulation, managing the reserve requirement, leads to the term “fractional reserve banking”, with banks owing more money to deposit customers than they have in reserve. However, contrary to conventional wisdom, in most significant western economies, there is no regulation directly limiting the bank’s ability to make these loans, with respect to its cash reserves. The reserve requirement ratio typically either does not exist, or it is so low that it has no significant impact. There is however a regulatory regime in place that does limit the expansionary process, these are called “capital ratios”. The capital ratio, is a ratio between the equity of the bank and the total assets (or more precisely risk weighted assets). The bank can therefore only create these new loans (new assets) and therefore new deposits (liabilities), if it has sufficient equity. Equity is the capital investment into the bank, as well as accumulated retained earnings. For example if a bank has $10 of equity, it may only be allowed $100 of assets, a capital ratio of 10%.

 

The credit cycle

To some extent, the dynamic described above allows banks to create new loans and expand the level of credit in the economy, almost at will, causing inflation. This credit cycle is often considered to be a core driver of modern economies and a key reason for financial regulation. Although the extent to which the credit cycle impacts the business cycle is hotly debated by economists. These dynamics are often said to result in expansionary credit bubbles and economic collapses. Or as Satoshi Nakamoto described it:

 

Banks must be trusted to hold our money and transfer it electronically, but they lend it out in waves of credit bubbles with barely a fraction in reserve

 

Ray Dalio, the founder of Bridgewater Associates (a leading investment firm), appears to agree that the credit cycle is a major driver of swings in economic growth, at least in the short term, as his video below explains:

 

 

The view that the credit cycle, caused by fractional reserve banking, is the dominant driver of modern economies, including the boom and bust cycle, is likely to be popular in the Bitcoin community. This theory is sometimes called Austrian business cycle theory, although many economists outside the Austrian school also appreciate the importance of the credit cycle.

The fundamental cause of the credit expansionary dynamic

The above dynamic of credit expansion and fractional reserve banking, is not understood by many. However, with the advent of the internet, often people on the far left politics, the far right of politics or conspiracy theorists, are becoming partially aware of this dynamic, perhaps in an incomplete way. With the “banks create money from nothing” or “fractional reserve banking” narratives gaining some traction. The question that arises, is why does the financial system work this way? The underlying reasons for this, are poorly understood, in our view.

Individuals with these fringe political and economic views, may think this is some kind of grand conspiracy by powerful elite bankers, to ensure their control over the economy. For example, perhaps the Rothschild family, JP Morgan, Goldman Sachs, the Bilderberg Group, the Federal Reserve or some other powerful secretive entity deliberately structured the financial system this way, so that they could gain some nefarious unfair advantage or influence? Actually, this is not at all the case.

The ability of deposit taking institutions to expand credit, without requiring reserves, is the result of inherent characteristics of the money we use and the fundamental nature of money. This is because people and businesses psychologically and for very logical practical reasons, treat bank deposits in the same way as “cash”, when they could alternatively be considered as loans to the bank. This enables banks to then expand the amount of deposits, knowing they are safe, as customers will never withdraw it, since they already think of it as cash.

Bank deposits are treated this way for perfectly reasonable and logical reasons, in fact bank deposits have some significant advantages over physical cash. Bank deposits are simply much better than physical cash. It is these inherent and genuine advantages that cause fractional reserve banking, not a malicious conspiracy, as some might think.

 

Advantages of bank deposits compared to physical notes and coins

Factor Bank deposit Physical cash
Security

Keeping money on deposits in financial institutions, increases security

The money is protected by multiple advanced security mechanisms and insured in the unlikely event of theft

Large physical cash balances at home could be vulnerable to theft or damage

Physical cash cannot be insured and storage costs can be expensive

Electronic transfers Using the banking system, it is possible to quickly send money effectively over the internet or by phone, across the world at low cost and at high speed If physical cash is used, then a slow, inefficient, insecure physical transfer must take place
Convenience

Using a banking system to manage your money, can result in a convenient set of tools. For example the ability to use money using your mobile phone or on your computer

Precise amounts can be sent so there is no issue with receiving change

Handling cash is often a difficult and cumbersome process. Precise amounts cannot be specified and one may need to calculate change amounts
Auditability Traditional banks offer the ability to track, control and monitor all transactions, which can help prevent fraud. This improves reporting and accountability With physical cash, effective record keeping is less automated, increasing the probability of fraud

 

The main features of the different types of money

Despite the strong advantages of bank deposits mentioned in part 1 of this piece, namely the ability to use it electronically, physical notes and coins do have some significant benefits over electronic money. The following table aims to summarize the main features of the different types of money, bank deposits, physical cash and Electronic Cash (Bitcoin).

 

Features of electronic bank deposits, physical notes & coins and electronic cash

Feature Bank deposit Physical cash Electronic Cash
Advantages of physical cash
Funds are fully protected in the event the bank becomes insolvent or inaccessible*
It is difficult for the authorities to confiscate funds
Funds can be effectively hidden from the authorities
Transactions cannot easily be blocked
Transfers can be highly anonymous
Transfers can be irrevocable
Transfers can occur instantly ? ?
Payments can occur 24×7 ?
Transaction fees are zero ?
Payments work during power outages or when communication networks are unavailable
Money can be used without purchasing or owning a device
Anyone can use the system, without seeking permission
Advantages of electronic systems
Payments can be made over the internet
Change does not need to be calculated
Payments can easily be recorded
Funds can easily be secured to prevent theft ?

Note: * Physical cash still has a potential problem with respect to the solvency, related to the policy of the central bank which issues the currency

 

Due to the strengths mentioned in the above table, physical cash will always have its niche use cases. However, on balance, banking deposits are superior to physical cash, for the majority of users. The ability to use bank deposits electronically is particularly compelling, especially in the digital age. As we explained in part one of this piece, it is this ability to use the money electronically that ensures there is always high demand for bank deposits, giving banks the ability to freely expand the level of credit.

 

The unique properties of Bitcoin

Bitcoin shares many of the advantages of physical cash over electronic bank deposits. Although Bitcoin does not have the full set of advantages, as the table above demonstrates. However the key unique feature of Bitcoin, is that it has both some of the advantages of physical cash and the ability to be used electronically.

Bitcoin aims to replicate some of the properties of physical cash, but in an electronic form, an “electronic cash system”. Before Bitcoin, people had to make a binary choice, between physical cash or using a bank deposit.

Although technically physical cash is a kind of a bank deposit, a deposit at the central bank, physical cash still has unique bearer type properties which could not be replicated in an electronic form. For the first time ever, in 2009, Bitcoin provided the ability to use a bearer type asset, electronically. The simple table below illustrates this key unique feature of Bitcoin and blockchain based tokens.

 

The binary choice in legacy finance & the new option Bitcoin provides

Bearer type instrument Electronic type instrument
Physical Cash (Notes & Coins)
Electronic money (Bank Deposit)
Electronic Cash (Bitcoin)

 

Therefore Bitcoin can be thought of as a new hybrid form of money, with some of the advantages of physical cash, but also some of the advantages of bank deposits.

 

Bitcoin’s limitations

Although Bitcoin has inherited some of the strengths of both traditional electronic money systems and physical cash. Typically Bitcoin does not have all the advantages of either electronic money or physical cash, however it is uniquely positioned to be able to have a subset of the features of each. This provides a new middle ground option.

For example, Bitcoin may never have the throughput of traditional electronic payment systems or the ability to use without electricity such as with physical cash. Although as technology improves, Bitcoin may slowly develop more strengths and gradually improve its capabilities, to narrow the gap.

 

The implications of these characteristics on credit expansion

Understanding the dynamics of these characteristics, can be useful in evaluating the potential economic significance of Bitcoin, should the ecosystem grow. Bitcoin has at least six properties which provide some level of natural resilience against credit expansion, which traditional money does not have. This is because the advantages of keeping money on deposit at a bank are not always as pronounced in Bitcoin, compared to the alternatives. However, Bitcoin is certainly not immune to the same credit expansionary forces which exist in traditional systems, indeed people can keep Bitcoin on deposit at financial institutions just like they can with physical cash. Bitcoin may merely have greater resistance to the same credit expansionary forces.

At the core of our reasoning, is looking at the advantages of bank deposits compared to physical cash, which are the characteristics that enable large banks to freely expand credit and evaluating to what extent they apply in Bitcoin. As the table below shows, the advantages of keeping money on deposit at a bank are less significant in the Bitcoin world, therefore we think Bitcoin does have some unique resilience against the forces of credit expansion.

 

Physical cash vs bank deposits compared to Bitcoin vs Bitcoin deposits

Factor Physical cash compared to deposits Bitcoin compared to Bitcoin deposits
1. Security

Keeping money on deposits in financial institutions, increases security relative to keeping large physical cash balances at home, where the cash is vulnerable to theft or damage

Bitcoin can potentially allow a high level of security, without putting the funds on deposit at a bank

For example Bitcoin can be concealed or encrypted

2. Electronic transfers

Using the banking system, it is possible to send money effectively over the internet or by phone, across the world at low cost.

If physical cash is used, then a slow, inefficient, insecure physical transfer must take place

Bitcoin can allow users to efficiently transmit money over the internet, without using deposits at financial institutions
3. Convenience

Using a banking system to manage your money, can result in a convenient set of tools. For example the ability to use money using your mobile phone or your computer.

Precise amounts can be sent so there is no issue with receiving change

Bitcoin can allow users to make payments on a mobile phone or without manually calculating change amounts. Deposits at financial institutions are not required
4. Ability to redeem deposits In the traditional banking system, withdrawing physical cash from a financial institution is a long administrative process which takes time. Banks therefore do not need to worry about keeping large quantities of physical cash in reserves Bitcoin can allow users to withdraw money from deposit taking institutions quickly, which may encourage banks to ensure they have adequate Bitcoin in reserve at all times
5. Auditability

Banks offer the ability to track and monitor all transactions, which can help prevent fraud and improve accountability.

Physical cash cannot offer this

Bitcoin’s blockchain or other electronic databases can allow users to effectively audit and monitor transactions, without using third party financial intermediaries
6. “Hybrid banking”

In traditional banking models there are only two fundamental choices:

1. Physical cash which provides full user control of the money

2. Money on deposit at a financial institution

This is a binary choice with no middle ground options, forcing consumers to make a difficult choice with no compromise option available

Bitcoin allows for a wider spectrum of deposit and security models, resulting in a more complex credit expansionary dynamic.

For example:

1. 2 of 2 multi-signature wallet, where the bank holds one key and the user holds another key; or

2. 1 of 2 multi-signature wallet, where the bank holds one key and the user holds another key

 

The economic consequences of less credit expansion

The consequences of the lower level of credit expansion this analysis implies, does not really say much about whether this potentially new economic model will be more beneficial to society, nor does it say much about whether Bitcoin will be successful or not. The former is something that has been heavily debated by economists for decades and the latter is a separate topic, in our view. Although, despite decades of economic debate, perhaps Bitcoin is sufficiently different to the money which came before it, such that the debate is required again, with new very different information. For example inflation or deflation, caused by cycles of credit expansion, may have very different consequences in a Bitcoin based financial system, than on one based on bank deposits and debt. A key problem with deflation in a debt based money system, is that it increases the real value of debt, resulting in a downwards economic spiral. For non debt based money systems like Bitcoin, it is less clear what the implications of deflation are.

Although Bitcoin may not necessarily result in a superior economic model, we think this analysis may suggest that Bitcoin may have some properties that make the economic model somewhat unique or perhaps interesting, compared to the possible models that came before it. Therefore it does look like an area worth examining.

To many, the ultimate objective of Bitcoin is to become sufficiently dominant, such that there is a significant decrease in credit expansionary forces, which can neutralize the credit cycle and therefore the business cycle. Although, this should be considered as an extremely ambitious objective, which we consider as extremely unlikely. And even in the remarkable circumstance that Bitcoin grows to this scale, other unforeseen economic problems, particular to Bitcoin, may emerge.

Postmortem: Downtime, 27 December 2018

On 27 December at 18:38 UTC, BitMEX experienced a minor outage for approximately 1 minute whereby the trading engine was unavailable. During this time, market data updates were not published over the Websocket API.

Additionally, REST API queries for trading related data (read-only HTTP GET requests, not order management requests) took longer to return than usual over a period of 23 minutes from 18:13 UTC to 18:36 UTC.

The root causes of both issues have been identified and we are working on permanent fixes to prevent a recurrence. Updates will follow in the future.

We apologise for the inconvenience. If you have any questions, please contact customer support.

New Bitcoin and Altcoin Quarterly Futures Contracts

On 17th December 2018, the March 2019 quarterly ADA, BCH, EOS, ETH, LTC, TRX, and XRP futures contracts will be listed:

  • BitMEX Cardano / Bitcoin 29 March 2019 futures contract (ADAH19)
  • BitMEX Bitcoin Cash / Bitcoin 29 March 2019 futures contract (BCHH19)
  • BitMEX EOS Token / Bitcoin 29 March 2019 futures contract (EOSH19)
  • BitMEX Ether / Bitcoin 29 March 2019 futures contract (ETHH19)
  • BitMEX Litecoin / Bitcoin 29 March 2019 futures contract (LTCH19)
  • BitMEX Tron / Bitcoin 29 March 2019 futures contract (TRXH19)
  • BitMEX Ripple / Bitcoin 29 March 2019 futures contract (XRPH19)

On the same date, the June 2019 quarterly BTC futures contract will be listed:

  • BitMEX BTC / USD 28 June 2019 futures contract (XBTM19)

The Price Crash & The Impact On Miners

Abstract: Cryptocurrency prices have fallen significantly in the past few weeks. In this note, we analyse the impact this price decline may have on the mining industry. The Bitcoin hashrate has fallen around 31% since the start of November 2018, equivalent to around 1.3 million Bitmain S9 machines. We conclude that many miners are struggling; however, we point out that not all miners have the same costs and that it’s the higher cost miners who switch off their machines first, as the price declines.

 

Overview

Since the start of November 2018, the Bitcoin price is down around 45%, while in the same period the amount of mining power on the Bitcoin network has fallen by around 31%. According to our estimates, this represents around 1.3 million Bitmain S9 miners being switched off. The mining industry may therefore be under considerable stress right now, due to the falling prices of cryptocurrency.

The prices have so far caused two large downward difficulty adjustments to Bitcoin, 7.4% and 15.1%, on 16th November and 3rd December, respectively. The 7.4% adjustment was the largest since January 2013 and the 15.1% adjustment was the largest since October 2011. The charts below are based on the daily chainwork and therefore reflect changes in network difficulty.

Bitcoin Daily Work Compared to the Falling Price

(Source: BitMEX Research, Poloniex)

Daily Mining Revenue and Cost

As the chart below illustrates, Bitcoin mining industry revenue has fallen from around $13 million per day at the start of November to around $6 million per day, at the start of December. This drop in incentives was even larger than the fall in the Bitcoin price, due to a delay in the way difficulty adjusts. In the six-day period ending 3rd December, 21.8% fewer blocks than the expected 144 per day were found, as miners left the network before the difficulty adjusted, and as a result, fewer blocks were found. Therefore in the short term, there was a 21.8% fall in mining incentives on top of the impact of the declining price.

Bitcoin Daily Mining Revenue and Expected Electricity Spend – US$m

(Source: BitMEX Research, Poloniex)

(Notes: Assumes an electricity cost of US$0.05 per KWH, assumes advertised Bitmain S9 specification)

 

Bitcoin Cash ABC Daily Mining Revenue and Expected Electricity Spend – US$m

(Source: BitMEX Research, Polonies)

(Notes: Assumes an electricity cost of US$0.05 per KWH, assumes advertised Bitmain S9 specification)

 

Ethereum Daily Mining Revenue and Expected Electricity Spend – US$m

(Source: BitMEX Research, Polonies)

(Notes: Assumes an electricity cost of US$0.05 per KWH, assumes 32Mh/s at 200W)

Miner Profit Margins

The chart below shows that prior to the recent crash, the industry was making gross profit margins of around 50% (these figures assume electricity is the only cost included in gross profits), while after the price crash, this fell to around 30% for Bitcoin and 15% for Ethereum.

Miner Profit Margin

(Source: BitMEX Research, Poloniex for prices)

Ethereum Mining Profitability

In the period, the Ethereum hashrate has only fallen by 20%, much lower than Bitcoin, (representing around 1.5 million high-end graphics cards), while the price decline has been more significant than Bitcoin, at 54%. Therefore, gross profit margins have declined even more sharply for Ethereum, but it is not clear exactly why this is the case.

There are a few potential reasons. It could be that Ethereum miners are more hobbyist minded and less profit focused, or Ethereum miners could have started from a higher gross profit margin position than Bitcoin, so they are less inclined to monitor the network and switch the miners off when necessary. As the data shows, Ethereum miner gross profit margins now appear significantly lower than Bitcoin, falling to 15% in the last few days, so this could change (Note: This analysis only included electricity costs, when including other costs, mining may be a loss making operation).

Bitcoin Cash ABC Mining Profit Margins

As the above chart shows, the Bitcoin Cash ABC gross profit margin went negative during the split into two coins, Bitcoin Cash ABC and Bitcoin Cash SV. The two camps mined uneconomically in a race to have the most work chain. Ten days after the split, on 25th November, the profitability of mining Bitcoin Cash ABC rapidly climbed up to around the same levels as Bitcoin. This appeared to indicate the end of the “hashwar,” which proved to be almost completely pointless, as the war ending had no clear noticeable impact on either the coins or their value.

As the latest data in the below table shows, the two sides are getting closer again with respect to total work since the split and its possible uneconomic mining resumes.

Bitcoin Cash ABC Bitcoin Cash SV
Log2(PoW) 87.753365 87.747401
Blocks                          560,091                              560,081
Cumulative total since the split
Log2(PoW) 82.189 81.875
Blocks                                   3,325                                   3,315
Mining electricity spend $7,939,318 $6,389,264
Coin price (Poloniex) $108 $94
Estimated mining gross profit/(loss) ($3,450,568) ($2,494,139)
Gross profit margin (76.9%) (64.0%)
Assume leased hashrate
Estimated leasing costs $14,608,345 $11,756,245
Estimated mining gross profit/(loss) ($10,119,595) ($7,861,120)

(Source: BitMEX Research, Poloniex for prices)

Flaws in the Above Analysis

The above gross profit margin charts do not show a complete picture. While the revenue figures are likely to be accurate, the only cost included is electricity. Obviously miners have other costs, such as the capital investment in the machinery as well as maintenance costs and building costs. Therefore, although the charts below show that the industry is highly profitable when only considering electricity costs, given other costs, the recent price crash is likely to have sent almost all the miners into the red. This indicates that miners invested too much in equipment and have achieved large negative ROIs.

Electricity Cost is Not Uniform

Another crucial point not reflected in the above analysis is the variance in electricity rates. The charts above assume a flat cost of $0.05 cent per KwH; however, not all miners have the same electricity costs and there will be a distribution.

As we mentioned above, 31% of the hashrate was shutdown in the period, logically those with the highest electricity costs should turn off their machines first. Therefore the average electricity cost on the network should have fallen considerably in the past month.

The below chart is an illustration of the above, it assumes that electricity costs are normally distributed with a standard deviation of $0.01 per KwH and that higher-cost miners switch their machines off first. Although this assumption is likely to be highly inaccurate and energy prices will not be normally distributed across the mining industry, from a macro level it illustrates a point and it may be more accurate than the above chart.

According to this analysis, average Bitcoin mining gross margins have only declined from around 50% to 40%, implying a far more healthy situation for the remaining miners.

Bitcoin Mining Gross Profit Margin (Illustrative)

(Source: BitMEX Research, Poloniex for prices)

When evaluating the potential negative impact of price declines on Bitcoin, analysts sometimes forget that not all miners have the same costs. It is these cost variances that should ensure the network continues to function smoothly despite large sudden price declines and allows the difficulty to adjust.

What Caused the Price Crash?

There has been considerable speculation around the causes of the price crash, with some saying miners sold Bitcoin in order to finance a costly hashwar in Bitcoin Cash. The cryptocurrency intelligence monitoring platform Boltzmann flagged to us that their platform had detected unusually large miner selling of Bitcoin on 12th November, a few days before the Bitcoin Cash split.

Boltzmann detected that net Bitcoin sales from miners were “17.5 standard deviations below [the] 3-month trailing average.” On further analysis, it appears these miners may have been a member of Slushpool.

Bitcoin miner net flow & price

(Source: Boltzmann, 12 hour aggregation of miner net flow)

Conclusion and Price Commentary

While it may be true that mining pools selling Bitcoin to fund losses in the Bitcoin Cash hashwar may have been a catalyst for the reduction in the price, we think it’s easy to overestimate the impact of this. We are in a bear market and prices are falling regardless of the news or investment flows.

Furthermore, in a bear market prices seem to fall on non-news or bad news and ignore good news, while in a bull market the reverse appears true. We think it’s likely that prices would have been weak regardless of any miner selling prior to the Bitcoin Cash split. For cryptocurrency, trader sentiment is king.

This is likely to be a very tough time for the mining industry. However, for miners with lower costs, our basic analysis indicates that the situation may be better than people expect. If the miners acquired their equipment from Bitmain at below-cost prices, they could still be in the green, even when including depreciation and other administrative expenses.

BlockMEX STO

Remember BlockMEX? Well the firm has limped along for several years. They have tried various business models. None have made any money. But that doesn’t matter, VC firms continue to shower the company with cash, and its valuation continues to rise. The CEO now has a great new idea. Let’s listen in on the recent board meeting.

Billy – Billy is the CEO of the company. He just joined as the previous dude got ousted. The VC firm The Blind Fund, who supplies most of the cash, ousted the previous CEO in favour of Billy who they thought would play ball better.

Kaiser Soze – One of the general partners at The Blind Fund.

Kaiser Soze – So Billy, what are we going to do to get some traction? It’s been over four years, and BlockMEX still makes zero revenue. You guys need to do something new.

Billy – Well, I have a new idea. ICOs are toxic. The projects are trash, and the regulators hate them. What about STOs, Securities Token Offerings?

Kaiser Soze – Tell me more.

Billy – Ok, so imagine you want to buy a fraction of a piece of real estate. And then you could trade your fractional ownership, which is represented by a token.

Kaiser Soze – Call me old fashioned, but isn’t that just a Real Estate Investment Trust (REIT)? Most stock markets around the world already have those.

Billy – But do REIT’s ride on a Blockchain? Do they use Distributed Ledger Technology to hold the record of the title?

Kaiser Soze – No, but they trade billions of dollars a day already, and you can easily trade them with your local broker almost everywhere in the world.

Billy – You don’t get it. If the token rides on a Blockchain, like the Ethereum protocol, then they reach help anyone anywhere. Like those poor investors in North Korea who have nowhere to put their savings. Now they can own a token.

Kaiser Soze – Anyone, really?!! It’s pretty clear these are securities, right?

Billy – Yes.

Kaiser Soze – So that means they are regulated, and in most places the exchange needs some sort of license.

Billy – Yes, that’s correct.

Kaiser Soze – The same license the incumbent exchanges already possess?

Billy – Correct.

Kaiser Soze – And the technology stack that operates the matching engine must also be approved by the regulator, right?

Billy – Correct.

Kaiser Soze – So you are replicating the same technology, getting the same license, to go after the same client base?

Billy – Correct.

Kaiser Soze – Ok, sounds like a winner. We can keep pumping money in, and make it up on volume. [The Blind Fund never saw a negative gross margin business they didn’t like.]

Billy – Exactly what I was thinking. Everyone is talking about STOs and how they are the future. Another type of STO is an equity offering of a startup.

Kaiser Soze – So how would that be different than doing an IPO?

Billy – Well many companies these days are staying private, the cost of doing an IPO and all the regulatory and compliance costs, are daunting—-especially for smaller companies. There should be a way for smaller technology companies to raise funds by selling some type of equity.

Kaiser Soze – Would these companies pay dividends? I’m assuming these are unprofitable companies.

Billy – Not only would they not pay dividends, there would be no audited accounts, or any duty to really explain anything to their investors.

Kaiser Soze – Wow, that’s amazing. How would this STO thing fit in on the balance sheet?

Billy – Not sure on that one yet.

Kaiser Soze – Traditional financial theory would suggest that this token is worthless because there is no cash flow.

Billy – Come’on Kaiser. We have been through this before. Traditional finance is dead. We are in a new paradigm. Don’t be a luddite.

Kaiser Soze – I know, I know. But if you are selling equity like securities, wouldn’t that need to be registered with a national regulator?

Billy – Shhhhhh.. Don’t tell anyone. We are just going to shoe horn this one in. Because we use a Blockchain and or Distributed Ledger Technology, those rules don’t apply. The best part is, we can absolve ourselves of any legal liability by basically telling investors when they buy these things they actually have zero rights. ROFL.

Kaiser Soze – Man, this Blockchain shit is LIT! You can do anything.

Billy – I know, right? Maybe the only thing we can’t do is become revenue positive.

Kaiser Soze – Don’t worry about that. I know some people in the desert, who have more cash than brains. They won’t let us down.

 

Polly Pocket Has Liquidity Issues

Overheard at the recent Polly Pocket Investor Day.

Polly Pocket is the managing partner of Polly Pocket Capital. The fund invests solely in tokens.

Schmuck is an investor in the fund.

Polly – Welcome everyone to our Investor Day. 2018 has been a challenging year for our fund but we are fully confident in our ability, over the long run, to deliver superior returns.

Schmuck – Speaking of performance, can I get some more colour on what your fund actually holds?

Polly – Great question. As you know, we don’t disclose exactly what we own, but I can give you a taste. Our fund is divided into listed and unlisted tokens.

Schmuck – Ok, what do you mean by listed and unlisted? I thought the mandate only allowed the fund to invest in tokens that are already traded on a secondary market.

Polly – Well, that is true. But we saw some great deals, so we created a side pocket. The side pocket contains all the pre-ICO deals that we invested in.

Schmuck – Hmm…So you basically can invest in whatever you like, regardless of the fund mandate?

Polly – In a nutshell, yes.

Schmuck – Greeeeaaat. How do you mark these illiquid, unlisted tokens?

Polly – As you know, due to our amazing connections, we get in on deals well before the unwashed masses. Typically we get a 70% – 90% discount to the last round where most of the plebes purchase these tokens. We then mark the value of the token to the last round price.

Schmuck – So if you invest a price of $1,and the last round which could be a very small amount of the total float, is sold at $10, you record a 10x gain?

Polly – Yes.

Schmuck – Does that also mean that I get charged management fees on the 10x value?

Polly – Yes.

Schmuck – Your liquid token portfolio got molly whopped this year, correct?

Polly – Yes.

Schmuck – So the AUM will get bled at an accelerated rate due to the marking of the side pocket? I’m am paying 2% on a 10x marked up illiquid token with no secondary market, and there is no visibility as to when it will actually list?

Polly – I mean that sounds worse than it is, but you are essentially correct.

Schmuck – Do you apply a haircut to this valuation because there is no liquidity, and an indefinite time to listing?

Polly – No. We believe there is extreme value, and this is reflected in the last round price. Our team of token experts really knows how to value these things.

Schmuck – Maybe, but the management fees paid on these side pocket investments could consume the entire value of the investors’ capital. What happens if I would like to redeem?

Polly – We would sell our liquid tokens first. Once that pool of capital is exhausted, we would be unable to meet your redemption request.

Schmuck – Is there no way to sell your interest in these projects? Have you ever tried?

Polly – Legally we can’t. The SAFT term sheet does not allow us to transfer our interest before the token lists.

Schmuck – So basically you are telling me, I’m up shit creek without a paddle?

Polly – I wouldn’t put it that way. Sometimes we suffer liquidity issues.

REAL TALK

The BitMEX Research team has compiled a list of tokens that raised over US$50 million that have yet to list.

 

 

These deals have massive valuations, and many of the most venerated token funds took down large chunks. It is unclear when, if ever, these deals will ever list on the secondary market.

Given the large amount of token supply out there, who will buy this shit?

Can you really mark these investments to the last round price?

There are anecdotal reports of funds attempting to sell their SAFT interest, and the prices offered were way below the last round price.

2019 is going to be the year of reckoning for many funds. You can mark something to an absurd level in year 1. But the meter starts again on January 1st. If these things come to market, there will be no accounting tricks to hide the gargantuan losses that these funds will post.

The Confession

Overheard in St. Patrick’s Cathedral in New York City.

Judas is an Ethereum developer; he’s had some bad luck. He is now at Church giving a confession.

Father is the Bishop.

Judas – Forgive me Father, for I have sinned. It has been one year since my last confession.

Father – Welcome my son, please tell me how you have sinned.

Judas – Well as you know, I am an Ethereum developer. But I believe I have given false witness to another god.

Father – Who would that be, the Devil, Satan himself?

Judas – No Father, my faith strayed. I believed in Decentralisation.

Father – Huh? Not sure I follow. Please explain.

Judas – I am an Ethereum developer. You know, the world’s virtual computer. I believed that using the Ethereum protocol I could decentralise anything. And I was specifically interested in the trading of financial assets, like stocks.

Father – Ok, but what would a decentralised stock market look like?

Judas – Well, anyone, anywhere could exchange stocks. You wouldn’t need to get approval from any government or a traditional exchange like the New York Stock Exchange or Nasdaq. It would also allow anyone to sell equity in their project to anyone in the world. In short, true financial freedom for everyone, everywhere.

Father – Heresy. You planned to usurp the Angels, the NYSE, and Nasdaq. Did you not consult the good book about our Lord’s relationship with those organisations?

Judas – I did, but I thought because I used the decentralised world computer, Ethereum, that our Lord and Saviour would not mind.

Father – Son, you did not read the Gospels close enough. Specifically, the Gospel according to Howie.

Judas – Well, I thought my lawyers were well versed in the Gospels. They told me that because it was decentralised, the Gospel according to Howie did not apply.

Father – [Shakes his head in sorrow] In my last sermon, I preached that the Lord’s children must be vigilant against false prophets. Specifically those wearing Brioni suits, and white Church’s shoes. These white shoe lawyers, care not for your soul, but only for their pockets.

Judas – Oh, I missed that one. I was too hungover after a night at the Box. We were celebrating our ICO.

Father – Ah, the ICO. I also lead a vigil against that tool of the Devil. But son, how is your project decentralised, if you personally launched an ICO, and profited from it? Surely, a truly decentralised project has no identifiable leader, and no one entity profits from its operation?

Judas – I realised the errors of my ways now.

Father – How has the Lord made you repent?

Judas – The Lord decreed that I must pay a large sum of money to absolve my sins.

Father – Better that, than the Lord sending you to Sodom and Gomorrah, a.k.a. Rikers.

Judas – I know, I am forever grateful to the mercy of our Lord.

Father – I am glad you have learned son. Our Lord is merciful. But he will strike rath down upon those who threaten his kingdom.

Father – Let us pray to our Lord and Saviour. In nomine patris et filii spiritus sancti JAY CLAYTON.