Since BitMEX launched on 24 November 2014, cryptocurrency derivatives trading exploded. I tried in vain to seduce various venture capital firms with the vision of the future that was all about derivatives trading. At that time, succour was not forthcoming; however, I could not be more pleased with my failures now standing in 2019.
 
The BitMEX XBTUSD perpetual swap and various other contracts traded on OKEx and Deribit are of the same ilk. These contracts all allow you to trade a fixed USD amount of Bitcoin. We call these inverse derivatives contracts. Many OG traders have heard me speak at length about the subtle yet profound implications of this contract structure. However, as many new traders now try their hand at derivatives trading, a refresher course is necessitated.
 
Contrary to popular belief, I don’t delight when I see the BitMEX Rekt twitter feed going bananas. I’m long-term greedy. I would rather you enjoy a long trading career earning a profit and paying BitMEX trading fees along the way, than blow up your equity capital during a liquidation. Therefore, it is in mine and BitMEX’s best interest that our traders are sufficiently educated about best trading practices.
 
I love our traders, but when I hear people smile and laugh about getting liquidated it makes me cringe. A real trader practices proper risk management, and that means never being liquidated.
 
You Gotta Go Down, To Go Up
 
Convexity or gamma is the second derivative of a contract’s value with respect to price. Used correctly convexity can supercharge your portfolio’s returns. However, if you do not understand how convexity affects a derivative you trade, you will get rekt repeatedly.
 
With inverse contracts, the margin currency is the same as the home currency. I will use the XBTUSD contract throughout this post.
 
Home Currency: XBT (Bitcoin)
Foreign Currency: USD
Margin Currency: XBT
USD Value: 1 USD
XBT Value: 1 USD / Price (XBT/USD exchange rate or .BXBT index)
 
I will dwell on how the XBT exposure of a long 100,000 contract position changes with respect to the price (.BXBT Index).

First, let’s look at the long side. In bull and bear markets, these will most likely be speculators. This makes sense because being long Bitcoin offers asymmetric returns. Bitcoin can rise to infinity, but can only fall zero. It is better from a return on equity perspective to go long the bottom, then go short the top. Those who picked up ETH below $100 know this acutely. Therefore, coupled with leverage, on the margin, longs in most market environments will be predominately speculators.

The first chart shows XBT PNL profile and curvature. The straight line is the PNL %  return if the contract moved in a linear fashion, the curved line is the long inverse contract position’s PNL % return. What you immediately notice is that you will lose more money when the market falls, and make less money as the market rises. This is suboptimal as you must post margin in XBT. Thus, your margin requirements increase in a non-linear fashion, and this is why longs get rekt quickly in a falling market. 

Now let’s examine the short side.  In bull and bear markets, these will most likely be hedgers and market makers. In both cases, these market participants want to lock in the USD value of Bitcoin. With inverse contracts, a long physical Bitcoin position coupled with an equivalent short XBTUSD position creates a synthetic USD position. If 100% of the physical Bitcoin is placed at cross-margin with BitMEX, you cannot be liquidated.

Unlike the long side, shorts benefit from positive XBT convexity. Shorts make more and more XBT as the price falls, and lose less and less as the price rises.

The take away from these two examples is that long speculators will be liquidated faster on the way down. This explains why dumps in these derivatives dominated markets are now more extreme than pumps and will continue so long as inverse style derivatives dominate the cryptocurrency derivatives markets.

The CME contract has a fixed XBT exposure regardless of the price, and the USD exposure varies linearly with respect to price. While this is great for USD benchmarked investors, it becomes problematic for those hedging their exposure. Bitcoin purchased to hedge a short CME position cannot be used as collateral with the CME. This presents some challenges for hedgers who hold physical Bitcoin, and market makers who must divide precious capital between derivatives and spot markets with no cross-collateral relief.

Did you take your losses like a champ, or bottom tick the market with your market close order? The first quarter of 2019 witnessed depressed volumes, volatility, and price. The local lows of late 2018 have not been retested; however the market chop makes me feel like I’m at the Saudi embassy.

The repair of crypto investors balance sheets is not done yet. Losses must be digested, and the unlucky masses must wage cuck a bit longer to get back in the game.

All is not lost; nothing goes up or down in a straight line. 2019 will be boring, but green shoots will appear towards year end. The mighty central bank printing presses paused for a while, but economic sophists could not resist the siren call of free money. They are busy inventing the academic crutches (here’s looking at your MMT), to justify the next global money printing orgy.

Do not despair. CRipple is still worth more than zero. And Justin Sun’s new age religion TRON, paired with the Pope CZ, tells us there are those still willing to eat shitcoins with a smile.

Electric Cars and Sand Schmucks

While Bitcoin is an innovative technology, the technical merits of the protocol do not exist in a vacuum. The world’s monetary situation is very important. It determines how willing investors are able to suspend disbelief and believe crypto fan boys and girls.

Throughout 2018 the omnipotent Fed began reducing the size of its balance sheet and raising short term interest rates. The world still beats to the tune of the USD. Financial institutions and governments require cheap dollars, and the Fed happily obliged since the 2008 GFC.

Tech VC funds won’t admit it, but cheap dollars are key to their business. How else can you convince LPs to continually fund negative gross margin businesses, until they “scale” and achieve profitability? Everyone wants to become the next Facebook.

When investing in government bonds yields zero or negative, desperate investors will do whatever it takes to obtain yield. Tesla is a perfect example. Lord Elon is a master at creating open-faced pits, and torching his investors’ money in them. Tesla does not belong on the Nasdaq, but rather as a speciality flavour at the New York Bagel Co.

The market disagrees with my Tesla melancholy, investors continue to line up to eat Elon’s sexy Tesla hot shit cakes. Can you blame them, after you are fully invested in the S&P500 where else will you be able to show alpha to your investors?

Another example of this free money folly is the Vision Fund.

1. Top tick the “Value” your investments while still on the Softbank’s books.
2. Find a group of schmucks from the sand (That’s where the former Deutsche credit boys come in, “Be Bold”)
3. Sell your mark-to-fantasy private Unicorns into the vehicle populated by your sand schmucks
4. Take your cash and payout to your Japanese investors as dividends.

These entities thrived while the Fed held rates at 0% and reinvested their treasury and MBS roll off. TSLA hit its all-time high in mid-2017. Since then Elon has struggled to generate enough buzz to keep his stock elevated. I’m sure he isn’t thrilled that bondholders are due close to $1 billion in cash because the stock price failed to scale $360.

The Vision Fund’s sand schmucks also got cold feet. They baulked when the fund proposed to invest an additional $20 billion into the We-Broke company. The check size got sliced down to $2 billion.

When dollars get scarce suddenly investors discover value investing all over again.

The height of crypto silliness in December 2017 occurred just before the Fed embarked on its quantitative tightening. The 2018 pain train spared no crypto asset or shitcoin.

But things are a changin’. The Fed couldn’t stomach a 20% correction in the SPX. In the recent Fed minutes, the dot plot now shows no rate increases for the rest of 2019. The Fed will start reinvesting its runoff in the third quarter. We are only a hop, skip, and a jump away from an expanding Fed balance sheet.

Beijing knows China must rebalance its economy away from credit-fueled fixed asset investment. However, Xi must not have the political cojones to push this sort of painful change through. Therefore, the PBOC said “fuck it” to any attempt to reign in credit growth. The two most important central banks are creepin’ back into a super easy credit regime.

Easy money will manifest itself in other higher profile and more liquid dogshit before crypto. 2019 will feature an IPO beauty pageant of some of the best cash destroying businesses. Uber, Lyft, AirBnB, and possibly the We company all are rumoured to IPO this year.

Lyft is apparently oversubscribed for its upcoming IPO. Oh baby, this is going to be a fun year.

If these beauties can price at the top of the range, and trade above the IPO price, we know that party time is back. Crypto will be the last asset class to feel the love. Too many people lost too much money, in too short a time period, to immediately Fomo back into the markets.

Get Excited

Green shoots will begin to appear in early Q4. Free money and collective amnesia are powerful drugs. Also after two years of wage cucking, punters should have a few sheckles to rub together.

The 2019 chop will be intense, but the markets will claw back to $10,000. That is a very significant psychological barrier. It’s a nice round sexy number. $20,000 is the ultimate recovery. However, it took 11 months from $1,000 to $10,000, but less than one month from $10,000 to $20,000 back to $10,000.

Melissa Lee peep this. $10,000 is my number, and I’m stickin’ to it.

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.