The implications for Bitcoin of the new Bitcoin Cash difficulty adjustment mechanism

Abstract: In this piece we examine the potential impact of Bitcoin Cash’s new rolling 24 hour difficulty adjustment algorithm on the Bitcoin network.  We look at the possible implications of price movements of Bitcoin Cash, with respect to hashrate oscillations between the two coins.



In our last piece we looked over the history of coins sharing the same hashing algorithm and some of the potential problems related to swings in the hashate between the two respective coins.  In this piece we look more closely at Bitcoin and how it could be effected by changes in the price of Bitcoin Cash.

Bitcoin has a longer difficulty adjustment period than Bitcoin Cash, a two week adjustment windows, compared to the rolling one day period Bitcoin Cash now has.  Therefore, in the event of price movements changing relative mining incentives between the chains, Bitcoin will be slower to adjust and achieve the the 10 minute target time than Bitcoin Cash.  This could be a potential problem for the usability or integrity of the Bitcoin network.


A worked example of a Bitcoin Cash price increase

For this rest of this piece, broadly speaking, we assume miners have the objective of maximizing profits in the short term.  In reality miners may also consider other factors or have other objectives, for example, to see their favorite coin succeed, their hated coin fail, or they may try to maximize the long term value of their investment in coins and mining hardware, by focusing on maintaining network stability.

The following scenario applies to an increase in the price of Bitcoin Cash,  similar logic can be used for other price movements:

  1. There is stable equilibrium, where each coin is approximately achieving its 10 minute target time and the hashrate distribution is broadly speaking allocated in proportion to the relative price of each coin.
  2. The price of Bitcoin Cash increases.
  3. Bitcoin Cash then has higher mining profitability than Bitcoin and a significant amount of hashrate moves over to Bitcoin Cash.
  4. Within a day, Bitcoin Cash’s difficulty re-targeting mechanism quickly adjusts, such that the Bitcoin Cash block interval is around 10 minutes.
  5. Due to the higher difficulty on Bitcoin Cash, some of the hashrate moves back over to Bitcoin.  The Bitcoin block interval is longer than 10 minutes, since not all of the hashrate moves back over.
  6. Within around two weeks, Bitcoin’s difficulty re-targeting mechanism adjusts, and Bitcoin’s block interval reaches 10 minutes again.  More hashpower moves back over to Bitcoin, such that the hashrate distribution is approximately in proportion to the new relative price of the two coins, an equilibrium state.

The below table illustrates the above example with actual numbers.


Illustration of hashrate oscillation dynamics – Increase in the price of Bitcoin Cash

Initial state Immediately after the price increase After the Bitcoin Cash difficulty adjustment After the Bitcoin difficulty adjustment
Relative prices
Bitcoin 1.0 BTC 1.0 BTC 1.0 BTC 1.0 BTC
Bitcoin Cash 0.2 BTC 0.4 BTC 0.4 BTC 0.4 BTC
Relative mining profitability
Bitcoin 1.00x 1.00x 1.00x 1.17x
Bitcoin Cash 1.00x 2.00x 1.00x 1.17x
Expected hashrate distribution
Bitcoin 83.3% 0.0% 66.7% 71.4%
Bitcoin Cash 16.7% 100.0% 33.3% 28.6%
Expected block interval
Bitcoin 10 minutes n/a 12.5 minutes 10 minutes
Bitcoin Cash 10 minutes 1.7 minutes 10 minutes 10 minutes

Source: BitMEX Research
Notes: The above model is an over simplification and excludes several other stages of hashrate oscillations.  The table assumes hashrate is distributed according the relative price levels of the two coins.  Transaction fee dynamics are excluded.


Implications for the Bitcoin network

The above illustrates that the Bitcoin chain could experience block interval swings for longer periods than Bitcoin Cash, due to the longer difficulty adjustment window.  However, the data also shows that even a large fluctuation in the price of Bitcoin Cash, from 0.2 BTC to 0.4 BTC, only increases the expected Bitcoin block interval by 25% to 12.5 minutes, after the Bitcoin Cash difficulty adjusts.

These slower blocks may generate some additional transaction congestion on the Bitcoin chain.  Although, somewhat ironically, this particular problem is likely to be of greater concern to Bitcoin Cash supporters than a Bitcoin supporters.  Many long term Bitcoin holders may not be concerned by periods of 12.5 minute blocks, as they are looking ahead to the long term, while this issue should be resolved within around two weeks.  Although this may be disruptive to users in the medium term, in our view, it is unlikely Bitcoin Cash will maintain such high levels of price volatility for extended periods of time.  Therefore the above problem may not be a serious concern.

However, it is possible that price volatility and therefore hashrate oscillations could remain for extended periods of time.  If this is the case, although Bitcoin may deviate from 10 minute intervals for longer periods, the magnitude of the deviation could be larger for Bitcoin Cash.  This could therefore impact both coins in a negative way.  Should this occur, the eventual Nash equilibrium end game solution could be merged mining, as we discussed in the previous piece.  Although due to the current confrontational political climate, reaching such a solution could take a considerable amount of time and reconciliation.


Bitcoin Cash difficulty adjustment schemes designed to cause disruption

There may be some small elements within the Bitcoin Cash community who wish to disrupt the Bitcoin network. For example, some people may have attempted to combine the timing of a rally in the price of Bitcoin Cash with a sharp downward difficulty adjustment caused by the EDA, to drive miners to Bitcoin Cash and disrupt the Bitcoin network.

If the plan is to cause this kind of disruption, one potential idea could be to increase the difficulty adjustment period, for example to a two month window form a one day rolling period.  This would mean that following a sharp price rally of Bitcoin Cash, the difficulty of Bitcoin Cash would take longer to adjust than Bitcoin.  Therefore Bitcoin Cash could remain more profitable than Bitcoin for longer periods, potentially causing disruption and transaction congestion on the Bitcoin network.

However, a long difficulty adjustment window like this may contradict the Bitcoin Cash philosophy. A shorter difficulty adjustment period, larger blocks and lower block times improve usability, which is a key focus of Bitcoin Cash.  In contrast, longer difficulty adjustment periods, smaller blocks and longer block intervals, may improve resilience, which appears to be a key priority for the Bitcoin community.  Therefore Bitcoin Cash is unlikely to adopt such a policy, in our view.

Another issue with this longer two month difficulty adjustment window is that the level of disruption to Bitcoin Cash, relatively speaking, with respect to periods with fewer blocks, will be even larger than for Bitcoin.  Therefore this approach could be considered a lose lose type scenario.  As we expressed above, ultimately, the win win scenario could be something like merged mining.

The Litecoin vs Dogecoin hashrate wars of 2014 & the implications for Bitcoin vs Bitcoin Cash

Abstract: In this piece we look at the hashrate oscillations between Litecoin (LTC) and Dogecoin (DOGE) in 2014.  We compare it to the current Bitcoin (BTC) & Bitcoin Cash (BCH) hashrate oscillations and  consider whether we can learn any lessons from “history”.



Although there are many crypto tokens, the number of proof of work tokens, with their own set of miners, is actually surprisingly small.  Therefore having two significant proof of work tokens, sharing the same hashing algorithm is quite rare.  There appear to be three major examples of significant hashrate oscillations caused by this, in blockchain history:


Year Coins Hashing algorithm
2014 Litecoin (LTC) vs Dogecoin (DOGE) Scrypt
2016 Ethereum (ETC) vs Ethereum Classic (ETC) EtHash
2017 Bitcoin (BTC) vs Bitcoin Cash (BCH) SHA256

Source: BitMEX Research


In our view there may be lessons to be learnt from comparing the 2014 Litecoin (LTC) vs Dogecoin (DOGE) and the 2017 Bitcoin (BTC) vs Bitcoin Cash (BCH) hashrate oscillations.

In early 2014 Dogecoin enjoyed a sudden meteoric increase in price (figure 1), such that mining incentives increased quickly, attracting significant hashrate over to Dogecoin.  This is analogous to Bitcoin Cash’s now infamous EDA, which resulted in sharp drops in the mining difficulty, such that Bitcoin Cash had higher mining incentives than Bitcoin, for some short periods.  Both instances caused sharp swings in the hashrate between the coins, causing network distribution, to varying degrees in each case.

Many are tracking the swings in hashrate between Bitcoin and Bitcoin Cash on the website. Due to the mentioned similarities, we will take a look back at the 2014 incident.  We will show some charts from this period, displaying hashrate oscillations, that some of our readers may be less familiar with.


Mining incentives vs the difficulty adjustment

The hashrate distribution between two tokens with the same hashing algorithm should, in theory, be allocated in proportion to the total value of mining incentives on each respective chain.  Mining incentives can be thought of the US Dollar value of both expected block rewards and transaction fees, in any given period of time.

Even when token prices, block rewards and transaction fee levels are stable, in the short term, within the difficulty adjustment periods, further oscillations may occur, because miners may switch to more profitable tokens with lower difficulty, until the difficulty adjust to an equilibrium position.


Litecoin vs Dogecoin in 2014

Dogecoin enjoyed a large price rally in early 2014 and then began to challenge Litecoin, for the title of the highest hashrate Scrypt token.  Litecoin has a 2.5 minute block target time and its difficulty adjusts every 3.5 days, in contrast Dogecoin has a 1 minute target time and at the start of 2014, it had a 4 hour difficulty adjustment period.


Figure 1 – Litecoin (LTC) vs Dogecoin (DOGE) price chart – US$ – 2014

Source: Coinmarketcap, BitMEX Research


The Dogecoin price increased at a much faster rate than Litecoin in the early part of 2014, although as figure 2 below shows, Dogecoin never really approached Litecoin’s market capitalization. Despite the lower market capitalization, the higher inflation rate of Dogecoin, meant that miner rewards were often higher, such that during some periods a majority of the Scrypt hashrate switched over to Dogecoin.


Figure 2 – Litecoin (LTC) vs Dogecoin (DOGE) market capitalization chart – US$ million – 2014

Source: Coinmarketcap, BitMEX Research


Dogecoin had a higher hashate than Litecoin in late January and then February of 2014, as figure 3 below demonstrates.  There was a period of around 1 month of regular swings between the coins, with the majority of miners switching back and forth.


Figure 3 – Litecoin (LTC) vs Dogecoin (DOGE) hashrate chart – billion hashes per second – 2014

 Source: Litecoin blockchain, Dogecoin blockchain, BitMEX research


In 2017, during periods when Bitcoin Cash had higher mining incentives per unit time than Bitcoin, many miners switched over to Bitcoin Cash.  However, this lesson appears to have been learnt first in 2014.  As figure 4 below shows, miners “followed the money” back then to.

A key difference is that even after the difficulty adjusted to the equilibrium level, in some periods, Dogecoin remained in the lead with respect to the US Dollar value of mining incentives.  In contrast, Bitcoin Cash’s incentive lead was always only driven by anomalies in the difficulty adjustment algorithm.  Bitcoin always having higher incentives per block than Bitcoin Cash.  Bitcoin Cash only had higher incentives due to its faster blocks and as soon as the difficulty returned to equilibrium levels, Bitcoin retained its position as the highest incentive SHA256 coin.


Figure 4 – Litecoin (LTC) vs Dogecoin (DOGE) – mining incentive (US$ per day) vs hashrate share – 2014

Source: Coinmarketcap, Litecoin blockchain, Dogecoin blockchain, Dogecoin Github, BitMEX Research
Notes: Transaction fees were not included in the mining incentive calculation


In order to calculate mining incentives for Dogecoin, we had to consider various events which occurred in 2014, including six changes to the block reward and two hardforks.  They are outlined in the table below:


Figure 5 – Dogecoin (DOGE) 2014 event timeline

Date Block number Event type Expected block reward Comment
New Old
14th Feb  100,000 Mining reward change  250,000 500,000 Random reward between 0 & 500,000 DOGE
17th Mar  145,000 Hardfork 250,000 250,000 Difficulty re-targeting period reduced to 1 minute from 4 hours.  Randomness removed from block reward.
28th April  200,000 Mining reward change 125,000 250,000
15th July  300,000 Mining reward change 62,500 125,000
11th Sept  371,337 Hardfork Merged mining with Litecoin enabled
2nd Oct  400,000 Mining reward change 31,250 62,500
14th Dec  500,000 Mining reward change 15,625 31,250

Source: Dogecoin blockchain, Dogecoin Github, BitMEX Research


As the table above indicates, on 17th March 2017, Dogecoin changed the difficulty adjustment algorithm, reducing the target time to just 1 minute (1 block), in order to try and alleviate some of the disruption caused by the hashrate volatility.


Merged mining

Eventually, in September 2014, Dogecoin activated its merged mining hardfork.  Merged mining is the process by which work done on one chain can also be considered valid work on another chain.  Dogecoin can therefore be thought of as an “Auxiliary Blockchain” of Litecoin, in that Dogecoin blocks contain an additional data element pointing to the hash of the Litecoin block header, which is considered as valid proof of work for Dogecoin.

The merged mining system is considered the ultimate solution to the hashrate oscillation problem, ensuring stability, even in the event of sharp token price movements.


Implications for Bitcoin Cash

In our view, the Bitcoin Cash community is unlikely to want to implement merged mining, perhaps for political reasons, in the medium term.  Some in the Bitcoin Cash community see Bitcoin as an adversary chain, rather than one which should coexist peacefully.  Allowing merged mining can be considered as the ultimate peace arrangement between two chains.  Initially some in the Dogecoin community were also unhappy about merged mining, but the community eventually realized it was the best solution to their hashrate oscillation problem.

However, Bitcoin Cash has recently fixed the EDA issue, which we first highlighted as a potential problem that requires a fix, in early September.  Perhaps the new one day rolling difficulty adjustment, combined with more price stability, may solve the hashrate oscillation problem, such that no more fixes are required.  If this doesn’t solve the problem, perhaps alternative difficulty adjustment schemes could be tried, before merged mining may slowly make its way onto the agenda.


Bitcoin Cash Futures Now Live

BitMEX BCHX17 Futures Now Live

We are pleased to announce that the BitMEX 24 November 2017 Bitcoin Cash / Bitcoin futures contract is now live.​

  • Symbol: BCHX17
  • Expiry Date: 24 November 2017 12:00 UTC
  • Contract Value: 1 BCH
  • Underlying: Poloniex Bitcoin Cash / Bitcoin exchange rate
  • Leverage: 20x

​BitMEX Bitcoin Cash Holdings

On or before 31 December 2017:​

  • The amount of Bitcoin Cash a user is entitled to is determined by their Margin Balance at 1 August 2017 13:17 UTC, a few seconds after block 478,588.
  • Users will not receive Bitcoin Cash, rather BitMEX will sell all users’ Bitcoin Cash, and credit their wallet with the Bitcoin proceeds.

BitMEX Future Hard Fork Policy

BitMEX does not agree with contentious hard forks, and does not accept the manner in which Bitcoin Cash was forked, or the lack of preparation or notice before the fork; we consider this a dangerous action that imposes unacceptable costs on end-users and businesses. Please read our Policy on Bitcoin Hard Forks for acceptable hard-fork criteria.

However, months after the fork, it is clear this coin still has value and popular demand, so we have decided to credit Bitcoin at the prevailing Bitcoin Cash price. Do not expect future coins to be credited in this way. BitMEX reserves the right to credit forks or not – in the presence of doubt, always withdraw first.

The Deutsche Bank Connection

Bankers are flocking to the cryptocurrency industry as both principals and employees of related companies, fund managers, and as individual traders. Amid the rush towards this decade’s green financial pastures, one office of one bank stands out, Deutsche Bank Hong Kong.

Deutsche Bank’s foray into investment banking began with its acquisition of Bankers Trust. The firm then proceeded to ditch its conservative German roots, and import the biggest swingers in the industry. A clique of Merrill Lynch bankers were brought in. Their ring leader was Anshu Jain.

The culture was cowboy. My Hong Kong summer internship interviews in 2007 illustrates this point.

The first round of interviews was in Philadelphia. In my second 2-on-1 interview I met the man who’s team I would intern on that summer. I had just returned from my semester abroad in Hong Kong. He asked me why I loved Hong Kong, and I said I loved clubbing. I then rattled of a list of my favourite establishments. He would later tell me, that’s what sealed the deal for me in his mind.

That night I took the whole Deutsche contingent to my favorite dingy Philly late night EDM club. It got messy.

In 2007, financiers thought they were gods. Hong Kong has never regained the energy I felt that summer. I interned on the Equity Derivatives sales desk. HR nicknamed this desk the Snake Pit, because of the aggressive personalities that worked there.

The 2008 graduate training program in London featured similar aggressiveness. Deutsche offered an all expense paid trip to London for three months for all incoming graduates. The Japanese grads were the most intense. One grad got so drunk, and vomited so hard, he was hospitalised with a broken rib.

That is a taste of how the youngins were trained at Deutsche. The firm fostered an aggressive culture focused on partying hard, and making money. Unlike more demure banks, no one at Deutsche was shy as to why they were in the game. Making money was the goal, and no one was censured for being too flashy.

As the financial services industry entered a secular decline after the 2008 GFC, Deutsche people scattered to the wind. Deutsche lied to the German regulators about the value of its assets in an effort to avoid becoming recapitalised by the taxpayers. In hind side, that was the dumbest move ever. Their competing American banks gladly took TARP funds, paid huge bonus, and repaired their balance sheets. Deutsche limped along, and is one of the worst performing banks since the crisis.

The Deutsche Hong Kong reunion was ignited by Bitcoin. For some reason, this particular office is very well represented in the Bitcoin industry. The individuals I will list all went through the graduate training program, and our Deutsche stints all overlapped.

Arthur Hayes, CEO of BitMEX, member of the 2008 graduate class. I worked in Absolute Strategies Group, and then Global Prime Finance as a delta one ETF, futures, and swaps trader.

Greg Dwyer, Head of Business Development at BitMEX, member of the 2009 graduate class. He worked on the commodity structuring desk in Singapore, and then worked with me on the delta one ETF market making desk.

Nick Andrianov, Risk Management at BitMEX, member of the 2007 graduate class. He worked on the Flow and Exotic Index Volatility trading desk.

Andrew Rizkalla, Trading Lead at Paycase, member of the 2008 graduate class. He worked on the Program Trading and Facilitation desks.

Kayvon Pirestani, Director of Institutional Sales at Coinbase, member of the 2005 graduate class. He worked on the Equity Derivatives Sales desk.

Gavin Yeung, CEO of Cryptomover, member of the 2010 graduate class. He worked on the Program Trading and Facilitation desk.

Neelabh Dixit, co-founder of Cryptomover, member of the 2013 graduate class. He worked on the Portfolio Trading desk.

Donald Day, CTO Bletchy Park Asset Management, member of the 2009 graduate class. He worked as a quant strategist for the Absolute Strategy Group.

The are two other Deutsche Bank HK former employees who did not wish to be mentioned.

All Hail The CME

Due to overbearing and counterproductive financial regulations, innovation is often rewarded with heavy fines and loss of licenses. An institution with billions of dollars of revenue at stake cannot take the regulatory and reputational risk dealing with Bitcoin unless someone else does it first.

Enter, LedgerX. For over four years, the firm pestered the CFTC to allow them to clear Bitcoin settled futures and options. The hard work paid off this fall when their markets launched. Less than two weeks later, the CME announced they too would join the club. The CBOE technically was the first legacy exchange to announce the impending launch of a USD settled Bitcoin futures contract; however, the CBOE will go live 2Q2018 and the CME plans to launch theirs by year end.

The only reason why some large financial institutions (FI) participate in the digital currency ecosystem is they cannot ignore an asset class that went from $0 to almost $200 billion in value in under a decade. Large FIs are severely constrained in their ability to deploy large amounts of capital due to counterparty risk on exchanges not compliant with their specific jurisdictional overseers. An exchange who they can already trade with, the CME, that offers Bitcoin trading products is exactly what they need to seriously get involved.

Custody Risk

A USD-settled Bitcoin futures contract is perfect for large traders who cannot or will not custody Bitcoin. This futures contract gives them exactly what they desire, a product that pays them fiat currency to speculate on a crypto currency.

From the CME’s perspective, they also absolve themselves of the risk of losing customer Bitcoin. This product requires almost zero technical innovation on their part.


The BitMEX XBTUSD swap is the most liquid Bitcoin / USD trading product globally. XBTUSD trades 5x – 10x more volume than the underlying index constituents, GDAX and Bitstamp, combined. XBTUSD’s daily trading turnover routinely exceeds $1 billion, and approaches $2 billion.

The CME index will include itbit and Kraken as well. For market makers who must hedge flow on the underlying exchanges, two seriously liquid derivative contracts will increase the volatility in the spot markets. It will also place immense strain on the spot exchanges’ infrastructure. Can these four exchanges stand up to the likes of Citadel submitting, amending, and cancelling thousands of orders per minute? Time will tell, but the CME is about to get a crash course in Bitcoin.

These issues probably influenced the way in which their index was constructed. The index methodology is overly complex in an attempt to deal with the forecasted liquidity and technological issues the leading spot exchanges face.

BitMEX takes a more laissez-faire attitude about the Bitcoin markets than the CME can afford. Every financial reporter will be watching for any misstep, and the headlines will come hard and fast highlighting any issues.

Market Fragmentation

The Bitcoin markets are highly fragmented due to different regulatory regimes and cultural differences between traders from different domiciles. The type of trader who can trade with the CME cannot trade with many of the exchanges where the reference pricing occurs.

This presents a trading opportunity of a lifetime for arbitrage funds who can straddle the regulated and unregulated exchanges, and who can trade across multiple jurisdictions. The divergences will become more acute as large positions are placed on CME and CBOE products.

Will the regulated derivatives follow or lead vs. the cowboy trading occurring in North Asia? From a market microstructure perspective, this will be a very interesting experiment.

ETF Anyone?

In the disapproval of the Winklevoss ETF COIN, the SEC stated that the absence of a liquid regulated derivatives market concerned them. If the CME doesn’t face plant, this will pave the way for the ETF. The SEC dances to the beat of large FIs. If the CME is reaping immense profits from a derivative, asset managers will want in on the racket via a listed ETF.

Much like LedgerX, the Winklevii might be bested by a large ETF manager like Blackrock or Vanguard, who now has the regulatory cover to apply for their own Bitcoin ETF. Blackrock vs. the Winklevii; who has more capacity to provide push jobs for ex-SEC staffers?

While futures will allow wealthy individual traders and large FIs to comfortably trade Bitcoin, an ETF that appeals to retail investors globally will completely change the paradigm. Starting next year, expect more noise about an ETF approval emanating from the SEC.

Slow then Fast

I did not expect institutional take-up of Bitcoin to grow this quickly. There is too much money being made by startups in the space for large FIs not to get involved. As more and more of the regulatory and repetitional risk is removed, institutions will continue to increase their involvement and exposure.

The Miner Short Squeeze

Positioning has begun in earnest. In the last newsletter, I highlighted BitMEX futures trading strategies centered around the SegWit2x hardfork. Three weeks hence, the futures basis indicates aggressive positioning by traders heading into the hard fork. In this post, I will examine advanced trading considerations and unwind strategies.

XBTZ17 In Context

Bitcoin is up over 7x since January this year. Given this aggressive bull market, futures should trade in contango. Longs must pay a substantial amount of interest to entice shorts to position themselves against the trend.

The below charts list the annualised % premium for the XBTM17 (June), XBTU17 (September), and XBTZ17 (December) Bitcoin / USD futures contracts.

Each quarterly contract existed during a price rally. However, the Bitcoin Cash and upcoming SegWit2x fork dampened the premium for XBTU17 and XBTZ17 respectively.

Max % Premium PA Max % Outright Discount
XBTM17 122.30% -2.28%
XBTU17 32.38% -5.62%
XBTZ17 42.47% -7.17%

The above chart illustrates that XBTM17, which experienced no hard fork during its existence, had the highest premium and discount. XBTU17 experienced its max discount during the Bitcoin Cash hard fork.

XBTZ17 is already pricing in the SegWit2x hard fork. If the max discount has already exceeded XBTU17’s, then we can expect a substantially larger discount directly preceding the SegWit2x hard fork.

The discount is a combination reflecting traders’ fears of a disorderly hard fork, and traders selling XBTZ17 vs. buying spot to create SegWit2x coins with no Bitcoin price risk. Due to the heightened risk and publicity surrounding the SegWit2x hard fork, the discount could reach up to 15% pre-fork.

The Unwind

This time around most savvy traders are short XBTZ17 basis. Basis = Future Price – Spot Price. Any time the basis trades flat to positive, they increase their short position. However, once the fork is over large percentage of the XBTZ17 open interest must close their positions.

Many traders might close their XBTZ17 short at a mega discount pre-fork, then switch to long basis to play the relief rally. But if everyone is the same way, many will give up profits during the unwind. Additionally, bullish speculators will jump in pre-fork to take naked longs anticipating a sharp rally after the fork occurs.


During my time at Deutsche Bank there was a certain French options trader that emitted a high pitched squeaky yell of “Short Squeeze” any time the market gapped higher into the close. The XBTZ17 market is primed for a short squeeze, and I believe profit maximising miners could initiate an even sharper rally higher.

The miners signed the New York Agreement (NYA) in an effort to save face and acquiesce to activating SegWit, while at the same time securing larger blocks in the future. The NYA headed off a chain split due to UASF, but Bitcoin Cash was launched as a direct result.

Bitcoin Cash has an 8MB block size without SegWit. As it stands now, there is no need for SegWit2x Bitcoin. However, the majority of miners continue to signal for the NYA.

Signaling for the NYA costs them nothing, and it does not mean they actually will support the hard fork with hash power.

What would happen to the market if at the last minute all the large miners stopped signalling for NYA and the hard fork didn’t happen? You know the answer, Pump City. The other consequence is a violent resetting of XBTZ17 basis. All those who went short basis to collect the B2X dividend would rush to unwind their trades at the same time.

BitMEX will not credit B2X coins. Therefore, XBTZ17 shorts will remove margin from BitMEX the day before the fork and deposit on an exchange that will credit B2X. That means the leveraged used by shorts will increase further putting their positions at risk of liquidation during a short squeeze.

If I were a profit maximising miner here is what I would do:

  1. Buy Bitcoin Spot
  2. Buy XBTZ17 futures at a large discount.
  3. Shortly before the hard fork deadline, stop signalling for NYA.
  4. Bask in the glory of the annihilation of shorts on margin and futures.

If you believe this thought experiment might become reality here is what you should do:

  1. If you are short basis (short XBTZ17 vs. long spot), unwind that trade at a profit.
  2. Go long basis while it is negative (long XBTZ17 vs. short spot).
  3. If your risk appetite is large, go naked long XBTZ17 at a negative basis.

SegWit2x Bitcoin Is Not a Dividend

B2X is different than BCH in that B2X supporters do not want their coin to be an altcoin. It will either become Bitcoin or nothing.That is why they refuse to implement replay protection which allows exchanges to safely support B2X.

In the event exchanges delay the listing of the B2X by even a day, by the time you theoretically could sell B2X, it might be worthless because it failed at supplanting legacy Bitcoin.

If you went short XBTZ17 basis at a flat to positive level, you are in the money. Closing the trade early and earning the expected dividend is prudent due to the fundamental differences between B2X and BCH.

Trading Tip: Attempt to obtain free Bitcoin Cash on Bitfinex

Abstract: In this piece we explain a reasonably risky way to obtain free Bitcoin Cash (BCH) on the Bitfinex platform, by purchasing the BCC token.  This BCC token represents the Bitcoin Core side of the Bitcoin Unlimited futures contract.


Strategy overview

As we explained in our piece a few weeks ago, Bitfinex allow their customers to trade various Bitcoin chain split tokens, however as we explained some of these tokens have overlapping periods.

One of these tokens, Bitcoin Cash (BCH), launched in August 2017, we discussed this token in our earlier piece on the subject.  The launch of Bitcoin Cash occurred during the Bitcoin Unlimited futures contract period.  Therefore in theory, those who held BCC (the “Bitcoin Core” side of the Bitcoin Unlimited contract), had their Bitcoins locked up in this contract at the time of the Bitcoin Cash hardfork.  When this contract settles in December, holders of BCC may receive some Bitcoin Cash.

Bitfinex even eluded to this with the following statement:

CSTs with overlapping contract periods and other forking events may need to be adjusted to reflect the correct economics. We are aware the the BCC/BCU CSTs need retroactive adjustments to reflect BCH, as well as BTG, after the event tomorrow. Similarly, BT1/BT2 may need to be adjusted to reflect any BTG that accrues to the locked up BTC. We have a plan for this and may not be able to implement it immediately, but it is fair to our users and will be applied retroactively in a non-intrusive way. More details will follow on this next week.

Source: Bitfinex


Investment recommendation

Due to the recent price rally in Bitcoin Cash, with it currently trading at around 0.35 BTC, in our view, it may be a good idea to invest in the BCC token on Bitfinex, to try to obtain some exposure to Bitcoin Cash, without paying for it.

There are two ways of achieving this:

  1. Buy BCC in the market.  The current price of BCC is around 0.96 BTC and in theory the price could increase and trade at 1.0 (Or in theory BCC could even trade at a premium to BTC, although new units can be created if this occurs).
  2. Deposit BTC into Bitfinex and then split it into BCU and BCC.  Then one could hold the BCC to the settlement date and hopefully obtain the free BCH.

There are some risks to this trade, as we explain in the section below.  However, with the recent rally in the BCH price, in our view, the risk/reward balance is somewhat favorable.


Investment risks

  • Distribution coefficient – Although the Bitcoin Unlimited futures contract launched prior to BCH, the split tokens could be created both prior to and after the launch of BCH.  Therefore there may not be sufficient BCH in reserve to allocate to all BCC token holders.  A distribution coefficient may be required in order to adjust for this.  Actually some market participants may create new BCC in order to benefit from the trading idea mentioned in this piece, which would make any distribution coefficient less favorable to BCC investors.
  • Bitcoin Cash price – The market value of BCH could fall substantially prior to the Bitcoin Unlimited contract settlement date.
  • Bitfinex Policy – Bitfinex policy with respect to this matter is uncertain and could change.
  • Counterparty risk – The risk that Bitfinex becomes insolvent prior to the Bitcoin Unlimited contract settlement date.


Non Empty Smaller Block Data By Mining Pool

Abstract: In this piece we present data displaying the proportion of smaller blocks produced by the different mining pools, over time.  This follows on from our piece last week looking at empty blocks.


Smaller blocks overview

Following on from our analysis on empty blocks last week, some readers asked for a similar analysis to be conducted for non empty but smaller blocks, by mining pool.  For your consideration, we present some data trying to capture the proportion of smaller blocks by mining pool.  We are not unable to draw any interesting conclusions from this analysis.


Charts illustrating the proportion of smaller blocks by mining pool


Figure 1 – Blocksize bucket analysis by mining pool (in bytes) – 2017

Source: Bitcoin Blockchain, BitMEX Research, (For mining pool name)
Notes:  Data up to 22nd October 2017. Mining pool with less than 800 blocks in the period is excluded


Figure 2 – Blocksize bucket analysis by mining pool (in bytes) – 2016

Source: Bitcoin Blockchain, BitMEX Research, (For mining pool name)
Notes:  Mining pool with less than 800 blocks in the period is excluded


Figure 3 – Blocksize bucket analysis by mining pool (in bytes) – 2015

Source: Bitcoin Blockchain, BitMEX Research, (For mining pool name)
Notes:  Mining pool with less than 800 blocks in the period is excluded.  BTCC Pool had many blocks with 2 transactions in this period


Figure 4 – Percentage of non empty blocks smaller than 10,000 bytes by mining pool – monthly

Source: Bitcoin Blockchain, BitMEX Research, (For mining pool name)
Notes:  Mining pool with less than 250 blocks in the the month is excluded



We chose 10 blocksize buckets:

  1. Less than 500 bytes
  2. 500 bytes to 5,000 bytes
  3. 5,000 bytes to 10,000 bytes
  4. 10,000 bytes to 25,000 bytes
  5. 25,000 bytes to 50,000 bytes
  6. 50,000 bytes to 75,000 bytes
  7. 75,000 bytes to 100,000 bytes
  8. 100,000 bytes to 250,000 bytes
  9. 250,000 bytes to 500,000 bytes
  10. 500,000 bytes to 1,000,000 bytes

The selection of the bucket boundaries was entirely arbitrary and therefore this could weaken the analysis.  Figure 1 appears to indicate that the 10,000 byte bucket may be most significant, due to the apparent spike for some miners in 2017.  Therefore non empty blocks less than 10,000 bytes were chosen as the range for the monthly chart, which is shown in figure 4.


Concluding remarks

As a reminder we do not believe any of the above data is strong evidence for covert ASICBOOST.  Others have argued that smaller or empty blocks by some mining pools could be considered as circumstantial evidence for covert ASICBOOST, without always providing data backing up these claims.  Our objective here was simply to produce charts illustrating the prevalence of these smaller blocks by mining pool.

Empty Block Data by Mining Pool

Abstract: In this piece we present data displaying the proportion of empty blocks (blocks containing only the coinbase transaction) produced by the different mining pools, over time.  We look at the mining methodologies pools could choose and how these policies could impact the proportion of empty blocks.


Empty Block Overview

We recently published a piece describing covert ASICBOOST and we explained the allegation that particular mining pools may be using this methodology.  Some claim that circumstantial evidence supporting this allegation, is that some mining pools produce more empty blocks (or more smaller blocks) than other mining pools.

Readers have asked us for data backing up this assertion, as only limited data has been published on this specific topic, as far as we are aware.  We are not going to draw any firm conclusions from the data on the prevalence of empty blocks, however we present it for your consideration.  We also explain some of the other potential reasons for empty blocks, including SPV mining and SPY mining.


Figure 1 – Summary chart – Rolling average percentage of empty blocks (over 1,000 block period) by pool

Source: Bitcoin Blockchain, BitMEX Research, (For mining pool name)
Notes: Data up to 25th August 2017. Due to the different frequency with which different pools find blocks, the same dates on the chart could reflect different periods


Charts illustrating the proportion of empty blocks by mining pool


Figure 2 – Percentage of empty blocks by pool – 2017 YTD

Source: Blockchain, BitMEX Research, (For mining pool name)
Notes:  Data up to 22nd October 2017


Figure 3 – Percentage of empty blocks by pool – 2016

Source: Blockchain, BitMEX Research, (For mining pool name)


Figure 4 – Percentage of empty blocks by pool – 2015

Source: Blockchain, BitMEX Research, (For mining pool name)


Figure 5 – Percentage of empty blocks by pool – 2014

Source: Blockchain, BitMEX Research, (For mining pool name)


Figure 6 – All time percentage of empty blocks by pool – Monthly data

Source: Blockchain, BitMEX Research, (For mining pool name)
Notes: Data only included if the pool found 300 blocks or more within the month, Data up to 22nd October 2017


Figure 7 – 2016 onwards – percentage of empty blocks by pool – Monthly data

Source: Blockchain, BitMEX Research, (For mining pool name)
Notes: Data only included if the pool found 300 blocks or more within the month, Data up to 22nd October 2017


Figure 8 – 2017 YTD – percentage of empty blocks by pool – Monthly data

Source: Blockchain, BitMEX Research, (For mining pool name)
Notes: Data only included if the pool found 300 blocks or more within the month, Data up to 22nd October 2017


Summary statistics by year (top 11 pools ranked by the last 12 months)


Figure 9 – Summary table for 2017 (to 25th August)

Pool # of blocks Average block size % Empty blocks
Antpool 6,298 897KB 1.8%
F2Pool 3,897 919KB 1.3%
BTCC 2,733 896KB 0.7%
Bitfury 2,852 965KB 0.0%
BW Pool 2,034 933KB 0.1%
ViaBTC 1,990 952KB 0.4%
BTC.TOP 3,199 978KB 0.7%
Slush 1,921 947KB 0.4% 2,265 951KB 2.4%
HaoBTC 931 957KB 2.3%
BitClub 1,236 980KB 0.0%
All Blocks 35,899 936KB 1.1%

Source: Blockchain, BitMEX Research, (For mining pool name)


Figure 10 – Summary table for 2016

Pool # of blocks Average block size % Empty blocks
Antpool 11,479 747KB 4.2%
F2Pool 11,444 772KB 0.9%
BTCC 7,023 718KB 0.8%
Bitfury 5,298 834KB 0.0%
BW Pool 5,373 710KB 2.5%
ViaBTC 1,995 822KB 0.7%
BTC.TOP 27 961KB 0.0%
Slush 2,842 720KB 0.5% 657 976KB 2.1%
HaoBTC 1,443 982KB 1.5%
BitClub 1,662 964KB 0.0%
All Blocks 54,851 776KB 1.8%

Source: Blockchain, BitMEX Research, (For mining pool name)


Figure 11 – Summary table for 2015

Pool # of blocks Average block size % Empty blocks
Antpool 9,815 484KB 8.2%
F2Pool 10,851 499KB 4.0%
BTCC 5,780 390KB 0.1%
Bitfury 5,459 604KB 0.0%
BW Pool 4,129 495KB 4.5%
ViaBTC 0 n/a n/a
BTC.TOP 0 n/a n/a
Slush 2,445 492KB 1.2% 0 n/a n/a
HaoBTC 0 n/a n/a
BitClub 210 509KB 0.0%
All Blocks 54,311 480KB 3.1%

Source: Blockchain, BitMEX Research, (For mining pool name)


Validationless mining – SPV mining & SPY mining

SPV mining

In order to build on top of the previous block and extend the chain, mining pools need the hash of the previous block, but not necessarily the full block with all the transaction data.  Mining pools are in a rush to make the chain as long as they can as fast as possible to increase profits.  Therefore miners often have a policy of trying to find the next block before they have even had time to download and verify the previous block.  If this occurs, a miner typically avoids putting any transactions in the block (apart from the coinbase transaction), as the miner may not know which transactions were in the previous block and including any transactions could result in a double spend, resulting in an invalid block rejected by the network.  The term used to describe this type of activity is “SPV mining”.

The efficacy of SPV mining is debated in the Bitcoin community, with advocates claiming this is legitimate profit maximising activity. While opponents of this policy claim it reduces the transaction capacity of the network (since empty blocks still keep the mining difficulty up) and that it increases the probability of an invalid block receiving more confirmations, ensuring the network is less reliable for payments as double spends are more likely.


SPY mining

Another term often used is “SPY mining”.  When a mining pool wants to get the previous block even faster, they often participate as a miner on a competing pool, but instead of adding actual hashpower to the pool, they use the access to the network to get access to the previous block hash even faster and then use this information obtained by “spying” on their own pool.


Pool policies

Different mining pools are said to have different policies.  For example AntPool is said to conduct SPV mining, while Bitfury is said to not engage in this practice.  As figure 9 shows, Bifury produced 0.0% empty blocks in 2017, compared to Antpool on 1.8%.  SPV mining is believed to be the primary cause of this difference.


The ASICBOOST allegation

The above factors may explain the difference in the proportion of empty blocks, rather than covert ASICBOOST.  Alternatively, there could be another factor which we are not aware of, neither SPV mining nor ASICBOOST, causing the variation.

However, those supporting the covert ASICBOOST theory have been able to use the empty block data to generate circumstantial evidence supporting their theory.  For example figure 8 could be said to demonstrate the following:

  • Up until April 2017 Antpool (orange) produced the highest proportion of empty blocks, at a rate far higher than its peers
  • In April 2017 this switched to (dark blue) a pool owned by the same company as Antpool
  • In October 2017, unknown miners (light green) started to produce empty blocks, as Antpool tried to conceal its policy even further

In our view this hypothesis is certainly possible, but also reasonably weak. Further evidence may be required to draw any firm conclusions.


The time gap between blocks

Another factor to consider is timing.  SPV mining occurs because miners are keen to get to work on the next block quickly, before they have had time to validate the previous block.  Therefore, in the majority of cases where miners do not quickly find the next block, say within 30 seconds, the impact of SPV mining should be limited, since miners do have time to validate.

Figure 12 below is a repeat of figure 3 above, except this time we have excluded the empty blocks which occurred within 30 seconds of the previous block being found.  This may partially remove the impact of SPV mining.  Although the data with respect to timing may not be reliable.


Figure 12 – Percentage of empty blocks by pool – 2016 (30 second gap or more from the previous block)
Source: Blockchain, BitMEX Research, (For mining pool name)
Notes:  The time gap may not be reliable


Smaller but non empty blocks

The analysis in this piece only looks at empty blocks.  The ASICBOOST allegation is not only about empty blocks, but also smaller blocks. Smaller but non empty blocks can also assist with covert ASICBOOST due to the smaller size of the Merkle tree.  In a later piece we plan to look at the proportion of these smaller blocks in more detail.

In the below analysis we compared the timing between the previous blocks and the blocksize, for two particular pools.  One which claims to do SPV mining (Antpool) and one which claims not to (Bitfury).

The charts illustrate that the variations between pools are not just about empty blocks, but also smaller blocks.  The charts show that Bitfury has a more “tidy” chart, with smaller blocks only occurring when the time gap between the previous block was small.  In contrast the Antpool chart appears more “messy”, with empty and smaller blocks more prevalent regardless of the time gap between the previous block.


Figure 13 – Antpool (2017 YTD) – Blocksize compared to the time gap between the previous block

Source: Blockchain, BitMEX Research, (For mining pool name)
Notes: The y-axis is the time gap from the previous block in seconds, the x-axis is the blocksize in bytes.  The time gap may not be reliable


Figure 14 – Bitfury (2017 YTD) – Blocksize compared to the time gap between the previous block

Source: Blockchain, BitMEX Research, (For mining pool name)
Notes: The y-axis is the time gap from the previous block in seconds, the x-axis is the blocksize in bytes.  The time gap may not be reliable


It is difficult to draw any firm conclusions from these charts.  However one ironic thing stands out to us, from this analysis.  The pools arguing most vigorously for larger blocks, tend on average, to produce smaller blocks.


The Bitfinex chain split tokens

Abstract: In this piece we look at the ten different chain split tokens that could exist on the Bitfinex platform in 2017 and some of the complexities and challenges involved.  There are circumstances in which the policies Bitfinex has chosen are unfair and place a burden on customers, however perhaps this could not be avoided.


Chain split token overview

Bitfinex chain split tokens – 2017

Source: Bitfinex, BitMEX Research
Notes: It is not known if the Bitcoin Unlimited chain will exist as a different coin to Bitcoin at the time the contract is due to settle in December 2017


The above diagram illustrates the 10 chain split tokens which could exist on the Bitfinex platform in 2017.  During the year various groups created spin-off coins of Bitcoin and Bitfinex provided its customers the opportunity to trade these tokens.  Typically each spin-off can result in three new tokens.  For example SegWit2x resulted in:

  • BT1 – The futures contract token redeemable for BTC after the fork
  • BT2 – The futures contract token redeemable for B2X after the fork
  • B2X – The SegWit2x token itself

As we explain below, allowing the trading of all these tokens results in operational problems for Bitfinex, places inconvenient burdens Bitfinex customers and results in various scenarios which are “unfair” for customers.  However, avoiding any of these issues is difficult and perhaps potentially impossible, given the complexities involved.  In many ways Bitfinex has done a service to the community by rising to the challenge and supporting these tokens.  Although, in some respects its actions may have been unfair to customers and the platform could have handled the situation better.

A full timeline of the events related to the 10 chain split tokens is provided in the table below.


Bitfinex 2017 Chain Split Token Timeline

Date Event From To Margin longs receive tokens Margin shorts owe tokens BTC lenders receive tokens* BTC borrowers owe tokens*
 18/03/2017 Optional Split BTC BCC + BCU n/a n/a n/a n/a
 01/08/2017* Distribution BTC BCH    
 06/10/2017 Optional Split BTC BT1 + BT2 n/a n/a n/a n/a
 23/10/2017 Optional Split BTC BG1 + BG2 n/a n/a n/a n/a
 24/10/2017 Conversion BG1 BTC n/a n/a n/a n/a
 24/10/2017 Conversion BG2 BTG n/a n/a n/a n/a
 24/10/2017 Distribution BTC BTG  
 27/10/2017 Buy back BTG BTC n/a n/a n/a n/a
 16/11/2017* Conversion BT1 BTC n/a n/a n/a n/a
 16/11/2017* Conversion BT2 B2X n/a n/a n/a n/a
 16/11/2017* Distribution BTC B2X  
 XX/12/2017* Distribution BTC BTU  ?  ?  ?  ?
 31/12/2017 Conversion BCC BTC n/a n/a n/a n/a
 31/12/2017 Conversion BCU BTU n/a n/a n/a n/a

Source: Bitfinex, BitMEX Research

  • The BCH distribution had a coefficient of 0.85 for lenders
  • 16/11/2017 is the expected date of the SegWit2x hardfork
  • The date of the Bitcoin Unlimited hardfork is not known, its not easy to define if the fork occurs due to some of the nuances in Bitcoin Unlimited and it may not occur at all
  • With respect to BTG and B2X distributions, lenders only receive the token when BTC is in “use as financing collateral”
  • We apologies for any inaccuracies in the above table


Margin positions & lending

As we mentioned in our previous piece on the SegWit2x hardfork, the spin-off token distribution decision for financial platforms is not straight forward.  There are essentially four options:


Potential financial platform policies regarding the distribution of spin-off tokens

Policy A Policy B Policy C Policy D
Split user Bitcoin deposit balances into BTC & spin-off  
Split user Bitcoin margin long positions into BTC & spin-off long positions
Split user Bitcoin margin short positions into BTC & spin-off short positions    
Bitcoin lenders are due back BTC & spin-off
Bitcoin borrowers owe BTC & spin-off  

Note: It is also possible to have a different policy with respect to Bitcoin lending and Bitcoin margin positions, which is not illustrated in the above chart.


BitMEX may choose policy A (or perhaps B in some circumstances), however Bitfinex typically chooses policies (or variant of the policies) C or D. While Bitfinex’s policies can be considered “fairer” in many respects, it can lead to some problems.  Supporting additional tokens can not only put additional burdens on the exchange, but also on customers, as the situation with Bitcoin Gold below illustrates.


Bitcoin Gold (BTG)  – The forced buyback

Bitfinex clients who were short BTC on margin at the time of the fork had a BTG liability added to their account when the fork occurred.  This needed to be done to balance out the impact of users who were long BTC on margin at the time of the fork and benefited by receiving BTG.

This places a burden on customers who were short, as they now have to go into the market and buy BTG to cover their positions, despite potentially having no interest or knowledge in BTG.  This may frustrate some customers as they were not given much notice in this particular case (perhaps under 24 hours).  Since margin trading may not be enabled on BTG, customers have been given three days to cover their BTG shorts, or Bitfinex may buy back the BTG for them in the market with their BTC.


Anyone with a negative balance resulting from being a BTC borrower at the time of the fork will need to buy back into BTG within 3 days or risk having the system do it for them

Source: Bitfinex


The issue may be of particular concern to Bitfinex customers, since the BTG token does not exist yet, nor is the client ready to be released, as further development work may be required.  The date Bitfinex enabled trading, 24th October, was only the date of the snapshot of Bitcoin balances, not when the token actually launched.  Therefore Bitfinex customers who were short BTC at the time of the snapshot will not be able to deposit BTG to the platform to cover their short positions, as the token does not yet exist and instead they appear to be forced to buy it on the market at Bitfinex.  There may be insufficient liquidity, which could cause problems.

Although this is “unfair” and likely to frustrate some customers, it is easy to criticize and there are no perfect policies.


The chain split tokens do not consider the impact of the other chain split tokens

The above contracts do not fairly reflect each other.  For example there was a distribution of BCH tokens in August given to holders of BTC.  However, holders of BCC never received any BCH. This problem is illustrated by the overlapping nature of the contracts in the chart above.

If Bitfinex wants to increase the complexity of the above even further, the following additional distributions could be conducted:

  • When the SegWit2x hardfork occurs, distribute BTG to holders of BT1
  • On 31 December 2017, the Bitcoin Unlimited contract settlement date, distribute BCH, BTG and B2X tokens to holders of BCC

Bitfinex may actually make adjustments for these events and even eluded to this possibility in a recent post.  It would be interesting to see if any of their customers actually demand this.

Smell That?

The putrid smell of Bitcoin shorts’ carcasses just became more pungent. The Bitcoin price pump from below $3,000 to almost $6,000 in under one month is truly astounding.

In that span of time China shut down three of the world’s largest exchanges. The New York Agreement signatories proceeded further with the scheduled SegWit2x hard fork. And heads of large banking institutions called Bitcoin a fraud.

Where to from here? How high can Bitcoin go? Is this just a flash of greatness to be followed by a century of misery?

The clues to the future of Bitcoin lie in the global currency and debt markets. The money printing orgy that allows central banks to monetise the debt of governments and large corporates created the environment for Bitcoin to thrive. Therefore, an examination of the total stock of money and government debt could give clues to the future price of Bitcoin.

From Investopedia:

M2 is a measure of the money supply that includes all elements of M1 as well as “near money.” M1 includes cash and checking deposits, while near money refers to savings deposits, money market securities, mutual funds and other time deposits.

The government debt statistics are in USD billions were obtained from a Bank of International Settlements report. The data is as of 30 June 2017.

Money is not just M2, but in our financialised world, sovereign-credit acts as a very important monetary instrument. It is why many economists label the currency system a debt-based monetary system.

Other debt instruments such as corporate debt, provincial or municipal debt also function as money. Each country is different in the ways in which other types of debt function as money. To remain consistent I only considered government issued debt.

Gold (XAU) is the analogue “I don’t trust the government” monetary instrument. Bitcoin (XBT) appears to be the digital version. For gold and Bitcoin I used the current value of the total supply of each currency as its M2 value. For government debt, each has a value of 0.

The above chart depicts the relative size of M2 + Government Debt for the four most important fiat currencies (USD, EUR, JPY, and CNY), Gold, and Bitcoin. The first salient observation is that Bitcoin’s market value barely registers on the graph vs. these larger currencies.

Debt must be paid back at some point with base money, M2. Therefore the more debt a country has vs. it’s base money, the more leveraged their financial system. Governments usually don’t worry about how debt will be repaid because they can continue to issue new debt to pay off old.

However, when the market refuses to roll over debt an affordable interest rate, debt must be extinguished. One theory of how overly indebted governments could reduce the Debt / M2 leverage ratio is to tender debt-backed money at higher and higher prices for real money such as gold. Paul Brodsky in Apropos of Everything I, II, and III lays out an excellent argument for why central banks would extinguish debt-money vs. gold. I don’t believe it is likely that central banks will add Bitcoin to their pool of assets. The more likely scenario is that inflation sensitive investors will tender their debt-money for a relatively cheap real digital monetary instrument such as Bitcoin.

The only reason Bitcoin deserves treatment in is this thought experiment is that against all odds, it is still here after 9 years. The price after falling 80% from 2013 highs to 2015 lows, is now almost 5x higher than the previous 2013 all time high. The other positive aspect is that after years of ignoring Bitcoin, many financial institutions are investigating how they can play the game.

The aggregate amount of government debt outstanding for the four fiat currencies listed is $38,334 billion. At current prices, gold and Bitcoin are worth 20% and 0.25% of the aggregate government debt respectively.

If Bitcoin is digital gold, than theoretically it could reach the same ratio as gold relative to aggregate government debt. That implies a Bitcoin price of $461,333 or an 80x increase in price.

Modesty is a virtue. Assume that Bitcoin achieves a 1% valuation relative to aggregate government debt. That results in a price of $23,065 or a 4x return from current levels.

The battle for $10,000 is one of perception. Bitcoin is still not very useful as a pure monetary transaction instrument given its price volatility. However as a store of value, if savers view it as a hard form of digital money, they will diversify out of debt-money into Bitcoin. This psychological transformation is underway. The longer the price stays at these levels, the more people will believe Bitcoin will exist decades in the future.

Trading ShitCoin2x

The underlying index for BitMEX futures and swaps contracts on Bitcoin / USD and Bitcoin / JPY will not include the SegWit2x coin (B2X). Theoretically the futures and swaps should trade at a discount to reflect the B2X dividend received by all holders of Bitcoin on the ex-date. My trading thesis is that similar to the Bitcoin Cash hard fork, the futures and swaps will behave as expected.

Savvy and unemotional traders made significant profits without taking any price risk by taking advantage of the market dislocations. The following trade ideas will focus on the XBT/USD spot market, the XBTUSD swap, and the XBTZ17 futures contract.

Trades Pre-Fork

Given the market knows that BitMEX will not adjust the underlying indices, XBTZ17’s basis will trade lower to reflect the implied value of B2X. Thankfully due the current bull market, XBTZ17 trades at a positive basis. This is a perfect entry point for the following trade.

Sell XBTZ17 vs. Buy spot Bitcoin

A few exchanges (Coinbase & Bitfinex) have already announced that they will disperse B2X to all holders of Bitcoin on the ex-date in a 1:1 ratio. Therefore, once the spread is put on, the physical Bitcoin purchased as a hedge should be sent to any exchange that will split the coins for you. This allows you to sell any B2X received immediately. He who sells first, sells best.

On the ex-date (expected to be on or around November 20th), you will receive B2X in a 1:1 ratio. These B2X coins should be immediately sold for USD. At the same time, the futures should trade at a discount or negative basis. The short futures position must covered, and the physical Bitcoin hedge sold as well for USD.

Initial Trade:

Short XBTZ17
Long XBT

At Fork Time:

Receive B2X

Trade Unwind Proceedure:

Close XBTZ17, by buying
Sell XBT
Sell B2X

Trade Profit and Loss

Because you were able to enter the futures vs. spot trade at a positive basis, the B2X you sold is pure profit. Also, because you were able to cover the futures contracts at negative basis you will pick up additional basis related profit.

If the futures are trading at a discount when you entered the spread, then you must predict whether the percentage discount is less than the expected B2X / Bitcoin ratio. Or you must have a longer term positive view on the value of B2X.

What Can Go Wrong

If you entered the futures vs. spot trade at a positive basis and the fork does not occur, you will still profit. However, you will be required to hold the spread until expiry in late December. Depending on your hurdle rate, this opportunity cost may outweigh the basis profit received.

If you entered the futures vs. spot trade at a negative basis and the fork does not occur, you will post a loss in the amount of the negative basis.

When you unwind the futures vs. spot spread, the futures contract might trade at a large positive basis. If this happens, you must hold the spread until expiry. The only thing you lose is opportunity cost on the capital tied up in the position.

Right Before and During the Fork Trades

In the hours preceding the Bitcoin Cash fork, the XBTUSD swap traded at a large discount, and the funding was negative. A negative funding rate means that shorts pay longs. This discount is due to traders selling XBTUSD vs. buying Bitcoin spot right before the ex-date so they can “create” B2X without any price risk.

Or traders fearful of negative consequences for Bitcoin due the hard fork are locking in the USD value of their physical coins. The XBTZ17 futures contract will also be sold such that it exhibits a negative basis as well.

Traders may earn the B2X USD value synthetically by taking these countertrades.

Buy XBTUSD vs. Short Bitcoin spot

Profit is earned two ways. Firstly, XBTUSD’s basis will swing from negative to flat in the hours after the fork. Your are long the basis, therefore you profit. Secondly, the funding rate is negative. You will earn Bitcoin interest ever 8 hours while the rate is negative.

Buy XBTZ17 vs. Short Bitcoin spot

XBTZ17 should trade with a negative basis as well. Traders can purchase the futures contract, and sell it hours after the ex-date once the basis rebounds.

The one wrinkle to these trades is where to short Bitcoin spot. This is a very important consideration. If the exchange where you short Bitcoin forces shorts to deliver B2X, then the trade should not be put on. Additionally, borrow rates for Bitcoin will spike shortly before the ex-date. It is entirely possible that borrow fees eclipse the basis and funding profit earned on the long XBTUSD position.

Most exchanges that offer margin trading will not force shorts to deliver or cover B2X. Forcing a large number of shorts to cover in the illiquid B2X spot market could be disastrous. Therefore, most exchanges will not credit Bitcoin lenders with B2X or force Bitcoin shorts to deliver B2X.