Bitcoin Backwardation

The problem with shorting a deflationary asset: unlevered, the maximum you can make is 100%. When longing, the maximum you can make is infinity. Helping the case for bulls is the fixed supply of Bitcoin. Leveraged speculators prefer to go long Bitcoin rather than short. As a result, quarterly Bitcoin futures usually trade at a premium (positive basis) to the spot price.

It is puzzling to many why BitMEX March 2017 Bitcoin / USD futures contracts, XBTH17, currently trade at a discount to the spot price. The same has been true of OKCoin quarterlies. This phenomenon is called backwardation. It is even stranger considering the impressive bull-run Bitcoin has experienced over the last year.

Why are quarterly futures are in backwardation? When will the curve normalise? I will attempt to answer these questions, but the result is speculative; I am using only publicly available information and logic to arrive at this hypothesis.

What Is Bitcoin Good For?

What can one do with Bitcoin after it is purchased? If you don’t use it as collateral to gamble or place speculative trades, most Bitcoin lies dormant in a wallet. Bitcoin as a means of payment is still in its infancy.

Holders constantly search for ways to earn a return on their Bitcoin. No sovereign governments, banks, or companies borrow in Bitcoin yet. Therefore there are no “safe” fixed-income Bitcoin products.

To meet this need, savvy entrepreneurs have set up funds that pay a guaranteed daily rate of interest if you invest Bitcoin. These funds are based purely on trust. They are especially popular in China. Figures well known in the industry would leverage their personal brand to get holders to invest in their funds. I commonly saw 0.01% per day offered.

Depending on your personal network, you could also borrow Bitcoin from large miners or holders and pay them interest as well. If you are able to take down a large size, you may borrow cheaper than 0.01% per day.

What safe investment pays out a daily nominal return in Bitcoin over 0.01%? Prior to this week, I assumed that most funds invested in mining operations. But now I have another theory.

The major Chinese exchanges (BTCC, Huobi, and; aka The Big Three) operated popular P2P margin platforms. Users lent each other Bitcoin and CNY, allowing the exchange to offer margin trading. The lenders would earn a healthy return without taking any Bitcoin price risk.

The most profitable trade was lending CNY. Speculators going long borrowed CNY to purchase Bitcoin. Interest rates averaged 0.10% per day.

Investors in the fund gave Bitcoin, and the fund operator paid them 0.01% in Bitcoin per day. This is what the fund operator did next:

Step 1

Sell a portion of the Bitcoin for CNY. I will assume 50% of Bitcoin assets are sold.

Step 2

Use the 50% of Bitcoin remaining as margin to buy quarterly futures contracts to cover the 50% short Bitcoin exposure. You don’t convert 100% of Bitcoin into fiat-cash so that you have sufficient Bitcoin-denominated margin to buy futures contracts. USD denominated futures contracts are the most liquid, so it’s likely that most simply bore the USDCNY currency risk.

In the past, XBTH17 and other competing quarterly futures contracts have traded at a premium to spot. Assume that you buy at an annualised premium of 20%, this then means that you effectively pay 0.055% per day. On a blended fund basis (remember you only used 50% of assets), you pay 0.0275% daily.

Your fund owes 0.01% per day to clients, and you pay 0.0275% per day on your long futures contract hedge. Your total cost is 0.0375% per day.

Step 3

Lend the CNY on a margin trading platform. Assume you can lend your CNY at 0.1% per day on one of the big three Chinese exchanges. On a blended fund basis, you receive 0.05% per day.

Your net carry is 0.05% minus 0.0375%, or 0.0125% per day.

If you have 10,000 Bitcoin under management, you earn a profit of 1.25 Bitcoin per day. You can increase daily earnings by increasing the amount of Bitcoin assets sold for CNY. If you sold 75% of assets, your net carry would be 0.02375% per day.

Step 4

After three months, the futures contracts will expire. At that point, you must long roll your contracts into the next quarterly. The spread between the two contracts represents the cost of carry for the next three months.


It is necessary to understand the mechanics that fund-operators must undertake when they pay back investors.

Suppose an operator raised 2 XBT. He sold 1 XBT and received $1000. He took the other Bitcoin and bought 1000 XBTH17 (March 2017) futures contracts at $1000.

The price of Bitcoin rises to $2000 and at that point the investor recalls his loan. The operator must return 2 XBT.

The 1000 long XBTH17 futures have a profit of 0.5 XBT: (1/$2000 – 1/$1000) * -$1 * 1000. He is still 0.5 XBT short. He receives the $1000 principle back from the margin loans he made. With that he purchases 0.5 XBT at a price of $2000. He can now return the full 2 XBT.

Inverse Futures PNL = (1/P1 - 1/P0) * -$1 * Contracts

The important fact is that he must sell futures and buy spot, which at the margin causes basis to fall. If too many investors unwind at the same time, the falling basis will move a futures contract into backwardation.

The Great Unwind

From 24 December 2016 to 5 January 2017, the price of Bitcoin went from $800 to over $1,200 equivalent in China. Volumes spiked and bulls were borrowing everything in sight to go long Bitcoin. To satisfy the demand the CNY need to come from somewhere. I don’t believe exchanges were re-hypothecating customer CNY. I believe the increased CNY demand was met by credit whales operating in the manner I describe above. The hedging pressure from credit whales and Bitcoin bulls caused the XBTH17 premium to reach 54% annualised on January 5th.

All of a sudden, the PBOC turned on the lights at the club. In response to pressure from regulators, Chinese exchanges ceased offering margin trading on January 11th. The very next day, XBTH17 entered backwardation. Existing loans were allowed to expire, but no new loans could be taken out.

Margin loans had 2 to 30 day terms. As loans expired, credit whales need to unwind their trades. That meant selling futures and buying spot with released CNY. This helped move the futures’ basis into backwardation.

The Fear Uncertainty and Doubt (FUD) surrounding what the PBOC would or wouldn’t do prompted speculators to short Bitcoin via futures. There was no more margin trading therefore futures were the only bearish instrument available. Even today, the PBOC has released no statement as to what policy actions will be undertaken as a result of their “investigations”.

In short:

Margin Book Unwind + FUD = Futures Backwardation

Curve Normalisation

By mid-February all margin loans will expire. Afterwards, selling pressure will be removed.

If the PBOC does not say anything directly pre or post Chinese New Year, it will be safe to assume the exchanges heard and heeded the intended message. The FUD selling pressure will cease.

The basis will slowly creep higher as longs regain confidence and bargain hunt. A violent short squeeze could happen, should one of these three following black swan events transpire before the expiry of March 2017 futures:

  • The PBOC aggressively devalues the Yuan. Bitcoin will catch a bid again as comrades look to preserve what purchasing power they have remaining.
  • Marine Le Pineapple Pen is polling well in French elections. If Le Pen becomes the favourite, global contagion fears will skyrocket as an EU breakup will look more likely.
  • Trump passes a massive infrastructure spending bill. This is “bigly” inflationary and will cause US rates to rise which will exacerbate the pressure on the PBOC to slice the Yuan.

Bitcoin will respond positively if any of these scenarios come to pass. If you believe these situations are remotely possible, it behooves you to begin building a long XBTH17 position and take advantage of the backwardation.

All Quiet on the Eastern Front

In October of this year, China will hold the 19th National Congress of the Communist Party. During this rocking party, new members of the Politburo Standing Committee will be chosen. The Committee is the nation’s highest governing body.

The number one goal of the Chinese Communist Party (CPC) is the continuation of the one-party rule. In the months preceding the conference it is paramount that China not lose face, internally or externally. No issue is allowed to overshadow this important jamboree.

Unfortunately, 2017 appears to be the year when tough economic decisions cannot be delayed any longer. China must rebalance its economy by growing household wealth. This comes at the expense of the previous “winners”, such as credit-intensive heavy industry companies.

Everyone knows what must be done, but it is proving very difficult to disenfranchise the wealthy and connected. To date, the PBOC has engineered a slow but steady depreciation of the CNY. Depreciation is the escape valve that must be activated to export the money being printed onshore; new money must be printed to help engineer a soft landing during the economic rebalancing. In reaction, citizens fearing future weakness are attempting to spirit their capital out of the country.

The PBOC aggressively closed the obvious ways that capital fled. After tickling 7.00, the PBOC began strengthening USDCNY. In Orwellian fashion, they combined this with a direct instruction to financial analysts: refrain from discussing future Yuan depreciation.

The word from Zhongnanhai was stability and above all else, silence. In any other year the PBOC might stand a chance to achieve the holy monetary trinity. That is, having a closed capital account, a fixed exchange rate, and independent monetary policy. Unfortunately for China, Trump won the 2016 election.

Jobs For The Boys

America and China are more alike than many would like to believe. Trump and the CPC both received a mandate to rule by creating an iron burrito and rice bowl. While Minnie’s Haberdashery don’t allow no Mexicans, the current demographics of America leave Trump no choice.

Trump will put the good ‘ole boys back to work by building roads, bridges, and airports. He will also coerce American companies to onshore production of products intended for the American market through punitive taxation.

Pepe Escobar had this to say about Trump’s true handlers:

The Masters have decided to reindustrialize the United States and want to take jobs back from China. This is advisable from the Chinese viewpoint; for why should they sell their work to the US for a dollar that has no intrinsic value and get really nothing back for the work.

These policies if enacted will be highly inflationary. The secular bond bull market that began with Reagan will end with Trump. Trump has shown it is fatal to campaign against providing middle-class jobs. Regardless of their hemming and hawing, his inflationary spending proposals will be approved by a so-called deficit conscious Republican Congress. [Sputnik]

Artemis Capital, whose pieces on volatility investing are excellent, had this to say:

He [Donald Trump] will lever, and lever, and lever, and lever… and lever… and then restructure his way to success, or whatever success is defined as by the broadest measure of popularity at any given time. Trumponomics, if it delivers, will be a supply side free for all: massive tax cuts, deficit spending to create jobs, financial and energy deregulation, business creation, and trade protectionism all driving inflation. More importantly, Trump sees bankruptcy as a tool and not an obligation and will have no problem pushing the US to the limits of debt expansion.

The largest debtor and creditor nations cannot both embark on the same economic policies. The world must soak up both USD and CNY paper. Unfortunately, most of the world would rather look at Ben Franklin than Chairman Mao.

The Dot Plot from Hell

Grandma Yellen and Trump will become fast enemies. In the minutes of the latest meeting, Fed governors explained their fears about inflationary fiscal policies. Many believe this prompted the Fed to forecast three 0.25% rate hikes in 2017, versus previous expectations of only two.

The Fed even floated a trial balloon that it may begin to unwind its portfolio. They rightly fear massive mark-to-market losses should rates spike higher in anticipation of the enactment of Trumponomics.

For China to suppress CNY currency volatility, they cannot have the USD continue surging higher. If the Fed actually raises rates as per schedule, China will be in a very bad predicament. Not only will China’s portfolio of US Treasuries decline in value as rates rise, unpatriotic comrades will find new and more imaginative ways to turn Yuan into stable USD assets.

The measure to watch for is CPI food inflation: especially the oink oink flavour. The PBOC continues to bail out local governments and SOE banks through monetary liquidity injections via Reserve Ratio Requirement cuts and reverse-repo operations. If this new CNY paper cannot be exported abroad because of tightening capital controls, the pressure will show up in food prices.

If there is a piece of data that doesn’t paint a pretty picture of China, authorities silence the messenger. Recently Beijing instructed the meteorological agency to stop producing smog alerts. Pollution in north-eastern cities such as Beijing and Tianjin has hit records this winter.

When the inflationary pressures present themselves in accelerating CPI inflation, the government may decide to omit this crucial economic statistic from publication. That is when you know something big will happen.

To alleviate the pressure, the PBOC will aggressively depreciate the Yuan.

Before or After

When will the PBOC release the pressure? Chinese New Year, which starts this Friday and lasts until February 2nd, presents a perfect opportunity. Banks are closed for a week. Central banks love to impoverish their citizens over bank holidays.

A one-off devaluation during New Year gives China breathing room leading up to October. If the USD strength continues and the PBOC does not devalue, the PBOC might be forced to rock the boat just a little too close to the big dance.

If they delay, then no action will likely happen before the October National Congress. For those expressing a view through digital currencies, the absence of CNY currency volatility may dampen the price of Bitcoin in the interim.

The October to end of year Bitcoin price performance was +70% and +84% in 2015 and 2016 respectively. In both cases, the PBOC took the scythe to the Yuan. Fall 2017 will see similar stellar price performance if the PBOC delays the inevitable.

Marine Le Pineapple Pen

Risk-off will rule if Le Pen claims victory in the April French presidential elections. She is tired of France waving the white flag in the face of German economic onslaught. She has vowed to offer a referendum on EU membership. Should a vote be held, there is a non-zero probability that the frogs will leap into a new boiling cauldron of their own making.

A real risk of an EU breakup launched by the zone’s 2nd largest economy will send the USD soaring. The rush to safety will decimate emerging market currencies. If the PBOC delays the devaluation, they run a real risk of emergency cuts in the summer due to European contagion.

Make Bitcoin Boring Again

The absence of margin and zero trading fees will certainly temper the desires of Chinese punters to trade Bitcoin. However, these actions by themselves do not preclude a bullrun, should the domestic currency continue to stumble.

The Invisible Bull

Monero (XMR) was the best performing digital currency in 2016, rising over 2,745%. Even if you didn’t enter at the beginning of the year, if held over the last month you would have doubled your money. In the last week, it is up over 30% in USD terms. The market capitalisation of Monero rose over 40x this past year. Monero recently bested Ripple and Litecoin to earn the 3rd spot behind the King and Kitten of Crypto (ETH).

Hold on – check out Big Daddy Vitalik’s kitten bag.

Okay, back to reality. Why is Monero so hot right now? A few months ago a few Darknet markets, AlphaBay and Oasis Market, began using Monero. This highlighted the need for a digital currency more anonymous than Bitcoin. The adoption by a real userbase gave Monero a distinct advantage over other anonymous currencies such as Dash and Zcash.

Kraken added Monero trading noting “Monero is built on the core principles of privacy, decentralization, open development, scalability and fungibility”. Coinbase received many requests to add Monero. However given the regulatory straitjacket Coinbase is under, color me surprised if they support trading of a fully anonymous crypto.

Monero transactions achieve anonymity by using ring signatures. The process is similar to a Bitcoin mixer, but is included in the protocol of the coin and is used by default. The effect of this is to make blockchain analysis much more difficult.

Zcash uses a different approached, called a zk-SNARK, which allows transactions to be completely anonymous. If this feature is not enabled, transaction processing and verification is the same as the Bitcoin protocol. Please read our article “The Battle For Online Privacy” for a further discussion of these two privacy protocols.

The Zcash mining reward is a point of contention. 20% of the reward goes to the founders which is what sparked the fork for Zcash Classic. Zcash Classic eliminates the founders’ reward and slow mining start.

Monero and Zcash have almost the same hashing power (60 MH/s). In the long-run however, given the tail-end emission of Monero (which negates the need to increase transaction fees or discuss block size debates), Monero will be the preferred coin to mine over Zcash which follows the Bitcoin protocol for mining rewards. In addition, those users requesting anonymity in their transactions would need to pay the miners more on Zcash than for a non-anonymous transaction, given the z-addresses are larger.

Image 1: Ratio of XMR / ZEC Price

As the above image suggest, Monero is currently starting to gain more momentum than Zcash, however the war will continue throughout 2017. The real battle begins when the supply of ZEC increases to a level where it can actually be widely used. Traders must ponder the switching costs between Zcash and Monero for Darknet market operators.

To add some tinder to the fire, effective Friday 6 January 2017 12:00 UTC, the leverage for XMR7D will be increased from 20x to 25x.

Happy Trading.

Big Door In, Small Door Out

China, once a cuddly panda, is now a violent dragon. The tide has turned, and financial transactions that were previously tolerated are now banned.

2017 has barely begun, and yet China has enacted a flurry of financial regulations to stem the outflow of CNY, and in its wake, arrest a whole-scale financial meltdown. USDCNY flirts with 7.00. Once that level falls, the light of financial truth will shine on China’s cockroach-infested capital account.

In a previous newsletter, I estimated that on January 1st, another $800 billion could legally leave China due to the $50,000 FX limit quota per adult. The State Administration of Foreign Exchange (SAFE) chose to begin enforcing current regulations which prohibit the use of the FX quota for investment purposes.

Comrades must now declare to their bank how their quota will be used. Overseas tuition payments, family visits, and medical treatment are permitted. Buying Hong Kong issued insurance policies, fancy flats in Vancouver and Sydney, however are forbidden. Should a comrade violate the will of Beijing and be caught, they forfeit their quota for up to 3 years. [Bloomberg]

Governments globally love to create endless pages of laws and regulations so they may cherry pick enforcement. Harvey Silvergate estimates that Americans commit three felonies per day. [WSJ] Committing a felony in America disenfranchises you for life. China is no different. The “law” is what the Party says it is, and it is almost impossible to predict what the “law” will be on any given day.

The Hong Kong Dollar Peg Will Fall

China’s woes don’t end with citizens converting CNY into USD legally. The CNH (offshore Yuan) plunge protection team is in full force. To deter evil speculators from shorting CNH, the PBOC has driven up the cost of borrowing CNH in Hong Kong to nosebleed levels. The CNH funding crunch will affect USD and HKD interbank lending rates for Hong Kong and Mainland banks.

The first tremors are being felt in the Hong Kong Interbank Offered Rate (HIBOR). HIBOR is at levels not seen since the 2008 GFC. [Analystz.HK] For year, wealthy Chinese have plowed into the Hong Kong property market. With Fed Funds at 0% to 0.25% for almost a decade, it was almost free to own Hong Kong property. The HKD is pegged to the USD, therefore Hong Kong imports American monetary policy.

Chinese investors purchased a USD asset, with leverage, with a very low interest expense. All they had to do was take a bus, ferry, car, or plane across the border to Hong Kong. No questions would be asked about the provenance of the cash used for the down payment.

If Hong Kong property prices begin to fall due to investors’ inability to fund their investment, it will be a stampede for the exit. But who will be left to buy? Beijing on multiple occasions has asserted its de facto control over Hong Kong. Booksellers have been apprehended, duly elected members of the legislative body denied entry, and the hope of universal suffrage in 2017 annihilated.

The city is gearing up for the 2017 Chief Executive (CE) election. Those who stand for CE must be approved by Beijing, and they are elected by LEGCO representatives. LEGCO is made up of unelected representatives from various business constituencies, and a smattering of popularly elected representatives.

The 2014 Umbrella Revolution in Hong Kong began when Beijing effectively said No to allowing the 2017 CE to be elected via universal suffrage. This violated their agreement with Britain during the 1997 Handover. Students took to the streets in protest. The protest eventually ended, but everyone knew the real battle would be this year during the CE “election”.

Beijing will unequivocally demonstrate that China owns Hong Kong. The implications for capital are severe. If Beijing controls Hong Kong, then the capital of those who believed they escaped the purview of Chinese financial regulators is fair game. Legally, there is no way to have squirreled enough money out of China to purchase a Hong Kong property. My childhood bedroom would be a multi-million dollar apartment were it situated in Hong Kong.

He who sells first, sells best. The Chinese will dump Hong Kong assets (i.e. property). The question is what to do with the HKD they have received. The first step is to convert HKD into USD. It is believed that the HKD is backed 1:1 with USD at the Hong Kong Monetary Authority (HKMA). We will find out the truth in that. If the HKMA has been cheating, the peg could fall under intense selling of HKD for USD.

The HKMA decreed the HKD can trade between 7.75 to 7.85 vs. the USD. My outrageous prediction for 2017 is that the HKD peg falls, and it trades materially weaker. A rush for the exits by Chinese asset holders will precipitate the fall of the peg. Then Beijing will make the political decision to weaken HKD aggressively to match where CNY is trading.

Beware of Chinese New Year

Last year, I falsely predicted that the PBOC would aggressively devalue CNY over the lunar new year. At the beginning of 2016, China’s “official” FX reserves stood near $4 trillion. This year, they stand at $3 trillion. The pace of outflows accelerated in 2016, and the pace of new financial regulations aimed at closing gaping capital account loopholes also intensified.

China must act swiftly before too much Yuan escapes. Another year of loophole whack-a-mole cannot happen. It is do or die time for Beijing if they want to avert a financial meltdown. Trapping CNY in the country to help fund a roll-over of the vast amount of corporate and local government debt is essential.

Over the next twelve months, savers will find holes in the enforcement of the FX quota regulations. Most likely they will bribe national banks’ local office managers to allow them to skirt the rules. China is huge, and Beijing’s control nationally is always touch and go.

Banks are closed from January 27th to February 2nd. A large one-off devaluation to USDCNY 9.00 would solve the problem. During the 1990s China faced a similar problem. Credit was overextended and 40% of Chinese banks’ loan books were non-performing (NPL). [The Diplomat] Analysts believe similar NPL ratios for Chinese banks exist today. A 30% devaluation would provide suitable breathing room for the PBOC to print enough CNY to paper over the problem.

The best case for China is to become the 21st century Japan. Japan avoided an outright financial collapse for almost 30 years by financially repressing savers with low interest rates. For China, this road starts with an aggressive devaluation.

Bitcoin, The Small Door

During times of financial panic, many alternative assets gain value. Bitcoin’s market cap is only $16 billion. Only a small portion of CNY will be able to find a home in Bitcoin. Even if the price grew 10x from current levels, Bitcoin would still not be able to absorb the sheer volume of CNY looking for a safe haven.

As Bitcoin nears all-time-high’s in CNY terms, desperate savers will investigate just what Bitcoin is. Many 2013 bubble bag holders will rekindle their love of Bitcoin and other digital assets.

Chinese savers aren’t stupid. The events around the globe have proven that central bankers will lie and lie, until the moment of truth arrives. Overnight Chinese households will see their wealth greatly diminished. The race is on to find a door out of China.

Those who previously found refuge in Hong Kong will need a new place to store their USD. It will flow into gold, shares of western blue-chip companies, and alternative assets like Bitcoin.

Why Beijing Hates New Year’s Day

Every Chinese comrade can legally convert $50,000 worth of Yuan into a foreign currency each year. That quota resets on January 1st.

Year to date, the Yuan has weakened 6.33% against the USD. China’s FX reserves have “officially” tumbled to $3.052 trillion, the lowest in six years.

China’s FX reserves are a representation of the gift that exporters were granted at the expense of households. The PBOC could sell USD and purchase CNY, strengthening the Yuan. That would provide households with better purchasing power for imported goods. However, this would hobble the politically powerful export lobby, and diminish the riches of many government officials.

Due to the enormous amount of credit created with fewer and productive uses for it, the PBOC must export deflation abroad by weakening the Yuan. Many emerging countries have faced similar problems, and the weakening episode was volatile and chaotic. The FX reserves are the PBOC’s volatility smoothing tool. Until recently, China had capital controls imposed on the poor, but left the door wide open for the elites to cut loose. Rich Chinese were allowed to leave China, and levitate global property markets to unseen levels.

The elites recognise that the priorities of the Party have changed. To maintain a harmonious society, Beijing must favour poor and middle-class households over industrial barons. That means the doors are shut for capital leaving China, which is also the cause of Xi Jinping’s anti-corruption campaign.

If capital flees too quickly, the PBOC will not be able to devalue the Yuan in an orderly fashion. I have detailed in various past newsletters the popular capital fight avenues that are now closed. But the biggest risk now isn’t large chunky transactions, but instead a flurry of small legal ones.

A Thought Experiment

According to the CIA World Factbook, China has 1.084 billion people over the age of 18. If just 61 million people (5.63% of those eligible) converted $50,000 of CNY into USD, then that would exhaust the FX reserves.

According to Household Wealth in China (Yu Xie and Yongai Jin), the top 10% of Chinese households hold CNY692,000 of assets ($100,000 equivalent). Housing assets account for 70% of wealth, so let’s assume a household consists of two adults and have $30,000 equivalent of cash that could be converted. This means that 54.19 million households could theoretically convert their $30,000 of liquid assets.

Prior to August 2015, the CNY was strengthening, however the mood has changed and most Chinese want to move their depreciating cash out. Assume that in 2016 each household converted $15,000 of CNY into USD, and then will convert another $15,000 in 2017. On 1st January 2017, the FX reserves then could fall by another $813 billion legally.

Due to prior economic commitments such as China’s One Belt, One Road project, and Asian Development Bank contribution, if the FX reserves fall below $2 trillion they are basically broke.

A drawdown of $813 billion would bring the official tally to $2.239 trillion. That is very close to the red line.

The PBOC’s Options

As much as the PBOC would like to reduce the quota to zero, that action would signal something is dangerously amiss with China’s capital account.

A reduction of the quota, would signal it’s do or die time to convert CNY into a real asset or strong currency. China is a large place, Beijing’s control fades quickly as you move outward. Beijing will not be able to efficiently stop the flood of money leaving the country through more nefarious means.

Instead, the PBOC will make the conversion process very difficult. Banks will be instructed to invent convoluted tasks and superfluous forms that customers must complete. Failure to dot all the I’s and cross all the T’s, will result in “Cannot”. If you have lived in Asia long enough, you know it is futile to debate a customer service representative once they utter “Cannot”. You must go back to square one, and correctly complete the stated process, however ridiculous and illogical it may be.

While comrades are busy filling out forms and standing in lines, the PBOC will take a machete through the Yuan like a young Thai coconut. They must move fast before too much money leaves via legal means.

PBOC is Fed Up

The pace at which the Fed governors forecast rates to rise in 2017 surprised markets. According to the Dot Plot, Fed governors forecast three 0.25% hikes next year.

While the markets initially rejoiced at rate normalisation, too much of a good thing is not wanted. It seems traders finally believe in discount rates again. Convexity quickly consumes profits when you move from zero to highly positive interest rates.

Grandma Yellen’s expressed concern regarding a substantial increase in fiscal spending. She cautioned that because the US is at “full” employment, fiscal spending at this point in the business cycle could be highly inflationary. Add a spike in oil prices, and you have the recipe for aggressive rate normalisation. That is deadly for the PBOC.

“From The Side Mate”

Starting January 1st, the vice constricting the PBOC tightens. Comrades will rush to the bank to legally convert their shekels, and a surging USD will increase the speed at which the CNY must weaken.

Until now the markets have shrugged off a weakened Yuan while they fêted Trump. The honeymoon is over. Expect global market volatility to ingest Yuan weakness, and output violent gyrations. Bitcoin will benefit from a weaker Yuan and greater global instability.

Santa granted my two Christmas wishes. All hail Bitcoin $1,000.

Quarterly Me Surprised

This Friday 16 December at 08:00 UTC, BitMEX will launch the 31 March 2017 Bitcoin / USD (XBTH17) and Bitcoin / CNY (XBCH17) futures contracts. Given the recent highs that Bitcoin has reached in terms of price and market cap, there is excitement building surrounding the launch.

The premium traders will pay to go long for three months represents the cost of unsecured USD, counterparty risk, and the bullishness of the market. There are several trading strategies that can be employed.

Cash and Carry

The simplest strategy, is to buy spot and sell futures to earn the basis. Remember, basis is the difference between the futures and spot price. Basis represents the cost of funds to buy Bitcoin using leverage. Arbitrageurs utilising this strategy effectively lend USD to speculators.

Capital is finite. Unless you plan to trade the basis, once the trade has been put on, it must be kept until expiry to earn the basis. The trick is to predict when during the life of the contract the outright basis will be the highest.

The above is a time series chart of the outright % basis between the Bitcoin / USD futures contract, XBTZ16, and spot. XBTZ16 was listed on 26 October 2016. Observing the chart, putting on the trade closer to the listing date, meaning when it has the greatest time value, generally gives the greatest outright returns. There are spikes during periods of high volatility, and when the price is rising.

Of the capital allocated to this strategy, use 50% within the first month of listing. Divide the remaining 50% into two tranches, and opportunistically employ the strategy during aggressive price spikes.

If the past is any guide, an outright rate above 5% is to be expected. If the rate rises above 6%, consider that a good opportunity to deploy any dry powder.

Fixed vs. Floating

More sophisticated traders can play the curvature of the term structure. The XBTUSD swap charges a funding rate to longs or shorts every 8 hours. This is a variable interest rate which depends on whether the swap trades at a premium or discount to spot. Longs pay shorts if the swap is at a premium, shorts pay longs if it is at a discount.

Traders who believe the XBTH17 basis is underpriced, can employ a curve steepening trade. They would buy XBTH17 futures vs. sell XBTUSD swaps. The Bitcoin / USD risk is eliminated, and what remains is a pure curve trade. If the XBTH17 basis increase is larger than the net funding being paid to a long XBTUSD swap holder, then the trade is profitable.

Traders who believe the XBTH17 basis is overpriced, can employ a curve flattening trade. They would sell XBTH17 futures vs. buy XBTUSD swaps. If the XBTH17 basis decline is larger than the net funding being paid to a short XBTUSD swap holder, then the trade is profitable.

As a point of reference, cumulatively since the May 2016 launch of XBTUSD, longs have paid shorts 30.74% outright (51.96% annualised). Assume from now until expiry of XBTH17, XBTUSD will have the same annualised variable funding rate. That would mean a break even outright basis of 14.95% would need to be earned by shorting XBTH17.

China Bitcoin Premium

The PBOC is expected to accelerate the devaluation of the Yuan in response to the Fed’s more hawkish tone. In the past, this lead to an expansion of the premium between XBT/CNY and XBT/USD.

The devaluation process will not happen overnight. The Bitcoin market will not fully price in a substantially weaker Yuan until it actually happens. When XBTH17 (Bitcoin / USD) and XBCH17 (Bitcoin / CNY) open, a suitable trade would be to go long the China Bitcoin premium.

To go long the premium, go long XBCH17 vs. short XBTH17. The Bitcoin risk is eliminated. What remains is a pure China Bitcoin premium play.

ETCWin and the ongoing Battle Between ETH and ETC

On the 5th December, BitMEX launched its first ETCWin token derivatives contract, WINZ16. It currently trades approximately 74% higher than its listing price. On the back of this successful launch, a number of traders are asking “What is ETCWin?” and “why the FOMO?”.

In a nutshell, ETCWin is a China-based Digital Currency Exchange Platform, built primarily for Ethereum Classic (ETC) trading. The exchange aims to list ETC pairs against XBT, LTC, XMR, and ZEC. The exchange will also allow trading of smart contract digital tokens, such as the ETCWin token (WIN). ETCWin also operates 91pool, an ETC mining pool with over 10% market share.

The exchange ran a successful ICO between 17th October to 23rd November, raising over 1,022,500 ETC. In return, the investors will receive 21% to 49% of project income and voting rights in the form of WIN tokens, which are based on the ETC protocol.

The WIN subscription price was 1 to 1.1 ETC, depending on the amount invested. Each WIN token represents 1 vote. Token holders can vote on development proposals 1 week in advance. A proposal that garners 60% of voters will be approved.

Why the Price Rise?

ETCWin has forecasted a dividend schedule based off approximately 3,000 XBT daily turnover. They predict a YTM of 54% in the 1st year, 153% in the 2nd, and 380% in the 3rd year. In addition, they proposed a buy-back schedule where they guarantee to buy back at 1 ETC per WIN.

They also have large backers and important members of the community behind them such as Chandler Guo, Roy Zou (CEO of Bitkio and a Core team member of ETC), and Feng Han (Blockchain Asia DACA Chief Secretary).

ETC is becoming more and more relevant in China as large miners and exchanges adopt it as the currency of choice given its immutability, and their ability to participate in discussions surrounding the future, compared to Ethereum (ETH) where the Foundation rules with an iron fork.

Both ETH and ETC have been on a one way trip against the King of Crypto that is Bitcoin, however ETC has reached 10% of the market capitalisation of ETH and remains a serious contender. Given the amount of investors and institutions backing ETH, it was easy to classify ETC as a pipedream.

China is the key to a future pump in the ETC price. It is telling that BTCC chose to list ETC trading before that of ETH. Many influential Chinese traders and miners vocally do not support ETH and the Ethereum Foundation. This angst lays the foundation for an ETC to ETH parity rally.

Want to Get Rich? Become an Indian Tax Agent

Indian Prime Minister Modi’s demonetisation drive has hit a major snag. He sold the program on the premise that tax evaders would be unable to wash their money through the banking system. That didn’t happen. Instead over 80% of all old bills were deposited into the banking system.

Businesses and individuals instead of producing value, were busy scheming on how to turn black money white. There were so many loopholes, that Modi was caught flat footed.

Indian’s love of gold was shown to be prudent. There is a reason why brides in India are decked in gold. It is a wealth transfer of massive proportions. Many believed that a bride’s gold was sacrosanct due to cultral factors, and no politician would dare strip brides of their lucre.

As predicted, Modi had to address Indian gold ownership for the digital currency drive to succeed. He recently decreed that gold is now subject to ex-post tax. Tax agents are raiding homes demanding owners poney up. Gold cannot be seized if it falls under certain thresholds. Married women are allowed 500 grams of jewellery, unmarried women 250 grams, and males 100 grams.

The most alarming facet of the “Raid Raj” is this tidbit: “Also, the ‘officer conducting [the] search has discretion to not seize [an] even higher quantity of gold jewelry.'” [Bloomberg] By giving tax agents’ discretion, Modi licensed theft. The tax man will demand a cut of your assets, otherwise he can legally confiscate them. As most people living in India know, just about every interaction with a civil servant involves some sort of bribe.

I am waiting for news reports about record numbers of applications for any open positions in the tax collection agency. Often times, the reason many people enter the government or civil service is to enrich themselves through bribery. Otherwise, why take a boring job that pays less than what can be earned in the private sector.

Bill and Hillary Clinton are role models. They admittedly left the White House “dead broke”. [PolitiFact] Since 2000, they have amassed a $100 million fortune. Their primary sources of income are speaking fees and income from their shady foundation.

After Hillary lost the presidential election, Australia ceased donating to the Clinton Foundation. The country had “donated” $88 million over the past 10 years. [] Surely poor children in Africa still need help. I guess these “donations” were given for different reasons.

The India Blueprint

Savers globally should study how Modi has stolen from his subjects. First he banned the use of physical cash in an economy where 90% of transactions use that payment mechanism. While the salaried middle and upper-classes were unaffected because they are banked, the majority of the working poor now had two problems.

First, they had to waste precious time queuing at banks to deposit their money. Second, it became much harder for them to accept payment for their goods and services.

Gresham’s law dictates that bad money will be spent, and good money hoarded. Modi had to attack gold, the widely held form of good money. By unleashing corrupt tax agents onto the populace, Modi has effectively killed the free ownership of gold.

In 1933, FDR signed executive order 6102, “forbidding the Hoarding of gold coin, gold bullion, and gold certificates within the continental United States”. [Wikipedia] Owners had to sell gold to the Federal Reserve at $20.67 per oz., or face criminal charges.

China recently curtailed the ability of some banks to import gold.

Some banks with licences have recently had difficulty obtaining approval to import gold, they said — a move tied to China’s attempts to stop a weakening renminbi by tightening outflows of dollars, the banks added.

The hit to gold imports comes as China tightens restrictions on overseas deals by state-owned companies in an effort to limit capital outflows that has seen the renminbi fall to its lowest against the dollar in eight years. [FT]

Gold is the most trusted and liquid form of non-government issued money. Time and again it has been proven that physical commodity money has one major drawback. It is physical, so confiscating it from citizens is quite easy. It is tough to transport and store large amounts of gold without government knowledge.

Cryptographic Money

Bitcoin is the most liquid form of cryptographic money. Because it is not physical, it is harder for governments to know you own it and subsequently confiscate it under the implicit threat of legal violence.

Rarely does the economic “ism” your country subscribes to guarantee economic freedom. Governments need control, and if gold ownership threatens their objectives it will be taken.

The challenge for Indians and other financially repressed people is how to acquire Bitcoin and other forms of cryptographic money.

It is harder to buy Bitcoin in American than it is in China. Circle, one of the largest VC funded payments / digital money startups, was initially founded with a vision to help people buy, store, and use Bitcoin. Due to oppressive financial regulations and harassment from state and government regulators, they cried uncle.

Circle will not longer help Americans buy Bitcoin. To their credit, Circle had one of the best customer experiences for buying Bitcoin. It is sad to see what happens in the Home of the Brave, and Land of the Free.

Contrast that to China, where you can deposit CNY through bank ATMs to fund your Bitcoin exchange account in minutes. There is ample liquidity, and no fees to trade Bitcoin.

There will not be a natural supply of Bitcoin in India until it is mined there. The 11% premium of Bitcoin in India will encourage entrepreneurs to start mining. Additional supply will come from businesses that can convert INR into USD and wire abroad. They will begin importing Bitcoin to sell at a generous markup.

The Day the World Stood Still

While president-elect Trump believes himself to be a BSD, the real commander in chief of humanity resides at The Marriner S. Eccles Building. One year after the first historic Federal Funds hike, Grandma Yellen will raise again.

The US Dollar is the king of all fiat currencies. Regardless of how many commentators warn of the impending doom for the USD, it is and will remain for some time, the global funding currency. Equities, commodities, and debt are all priced in some way off of the USD.

Trump’s inflationary intended fiscal policies are the cover Yellen needs to continue rate normalisation. Luckily for Yellen, the hubris of equity investors globally remains. They pay no heed to the future higher cost of funds; they believe the free money party will last forever. Even in the face of a steadily depreciating Chinese Yuan, the S&P 500 and Dow Jones continue to hit new highs.


As always, the real concern is China. Leading up to the Fed meeting Wednesday December 14th, the PBOC has steadily sliced the Yuan. Usually this creates panic in global markets; however, Trump stopped all that. The Make America Great Again president-elect will go on a debt binge that his Republican compatriots in charge of Congress fully support.

The market cannot get enough of the government spending more of other people’s money it doesn’t have. Look at how China’s fiscal spending levitated global markets in the wake of the Global Financial Crisis of 2008.

China’s inability to spook Yellen meant that it went into overdrive closing the most egregious capital flight thoroughfares. Chinese companies completing offshore M&A deals must now receive approval. Shady Chinese insurance companies will think twice before buying hotel chains.

Chinese who make the Haj to Macau will face more scrutiny. Macau may require pilgrims to declare cash in excess of $15,000. Macau gaming stocks got hammered in Hong Kong when that announcement surfaced on December 2nd. [Bloomberg] China could choose to raise domestic interest rates to make holding CNY more attractive. However, corporate and local governments would be forced to pay higher costs to roll over debt. And more importantly, financing rates for property companies and punters would skyrocket, collapsing the one asset class performing well in China.

Desperate comrades stung from the 2015 stock market collapse, and unable to afford or purchase additional properties, then turned to the commodities market. Speculators flooded the futures exchanges causing sharp rises in industrial commodities. Beijing shut that down as well. Exchanges were instructed to raise margin requirements and fees to deter speculators. It worked. Volumes and prices crashed across the board.

A recent Quartz article highlighted the plight of retail speculators. They interviewed several punters who have recently started trading Bitcoin. They like the 24/7 markets and high volatility. Some grasp the technological and economic genius of Bitcoin, but most just want a new, volatile, and non-governmentally controlled asset to punt.

China Bitcoin Premium

During the recent Bitcoin rally, the China Bitcoin premium rose to 4.50%. As the rally stalls, the premium is contracting. The premium will continue to contract leading up to the Fed meeting.

This week, BitMEX launched a 100x leveraged Bitcoin / CNY futures contract, XBCZ16. Combining XBCZ16 and XBTZ16 (Bitcoin / USD underlying), traders can directly trade the premium without Bitcoin price risk.

Trade Recommendation

Go long XBTZ16 vs. short XBCZ16 between now and the Fed meeting December 14th. If the Fed raises rates as most expect, reverse the trade, go long the premium by shorting XBTZ16 vs. going long XBCZ16. The trade thesis is that the PBOC will devalue the CNY to 7.00 against the USD. This will lead to an aggressive premium expansion.

A December to Remember

On December 4th, an Italian constitutional referendum and the Austrian presidential election will be held. Should Italians vote No, and Eurosceptic Norbert Hofer achieve victory, say hello to risk-off with a vengeance.

Bunga Bunga

Prime Minister Renzi stated that he will resign if the new constitution is not approved. Like most governments, needless complexity is created to confuse, distract, and discourage normal citizens from challenging their overlords. The Washington Post provides an excellent summary of what Italians will vote on:

Why Is There a Referendum?

The highly contested bill finally passed through parliament earlier this year, but it didn’t receive the qualified two-thirds majority of votes needed to change the constitution. So, Renzi had to seek a referendum. [WP]

The Issue in a Nutshell

There are other aspects of the proposal that are also important, however. One major one would attempt to clarify the balance of power between the regions and the central government, largely granting the former more control. Then there’s also the separate, but deeply intertwined, issue of Italicum, Renzi’s new electoral system for the Chamber of Deputies. [WP]

Italicum Huh?

The system effectively means that a party will be able to hold a majority in the Chamber of Deputies without winning a majority of seats. It seems designed to create a true two party system, like that of the United States or Britain. [WP]


Renzi is tired of minority parties causing trouble for his government. He is stripping them of power by reducing the threshold needed to capture and hold a government, and increasing the power of the Federal government at the expense of more autonomous regions and states. It is understandable that many voters are chafing at the possibility that their voice in any government will be sharply curtailed.

Why Are the Markets Spooked?

Renzi went for broke by declaring he will resign if the referendum fails. Bebbe Grillo’s Five Star Movement (5SM) is waiting in the wings. 5SM’s popularity has surged since 2012 on the back of virulently anti-establishment and anti-EU rhetoric. If elected into power, Grillo plans to force a vote on Italy’s EU membership.

As always, the problem leads back to Italian banks. They are broke. The willingness of the private capital markets to keep them afloat is wearing thin. Absent a bail-out from the ECB, which must be voted on by the governing council, a bail-in will happen.

A bail-in consists of senior debt holders or depositors taking a haircut. Both means of capital replenishment will cause harm to small retail investors and or savers. This is political suicide, and will commence an Italian and European bank run.

Europeans looked the other way when wealthy Russians lost their Euros in Cypriot banks, and when their feta eating brothers and sisters were pick pocketed. But if Italian savers get bagle’d, it will be impossible for Europeans not to run for the exits. The bail-in rules not only apply to Italy, but to every EU country.

Italian sovereign credit spreads blew out, and Italian bank equity prices are collapsing. If Renzi is not at the helm to appropriately fluff Draghi, then all bets are off. Super Mario and Frau Merkel will punish Italy for electing an anti-EU party by denying the country the funds it needs to fix its banks.

Hofer vs. Van der Bellen

Norbert Hofer is described as a far-right Eurosceptic candidate. Alexander Van der Bellen is a centric Euro-friendly candidate. Hofer narrowly lost to Van der Bellen in a presidential run-off earlier this year. However, the results were annulled due to voting irregularities.

Polls indicate that Hofer will take the prize. He is widely known for his stance that Austria should leave the EU. Post Brexit he walked back his rhetoric when it appeared that many Austrians were not so pleased that Britain vacated the sacred union.

EU bureaucrats are terrified that Hofer will call a referendum on Austria’s continued membership in the EU. European president Drunker Junker, known for his vino consumption habits, voiced grave concerns about a Austrian EU membership vote.

Jean-Claude Juncker has urged EU leaders not to hold referendums on their membership of the bloc because he fears their voters will also choose to leave. The European Commission president said giving people a vote would be ‘unwise’ as they could seek to replicate Brexit. [ZH]

After Brexit, another chink in the armour from a continental European country exiting could prove fatal for the EU. When the future of the EU is questioned, all eyes turn to the member banks. Bond holders fear redenomination of their debt assets into greatly depreciated national currencies.

Le Pineapple Pen

The French presidential election is not until 23 April 2017. The two front runners are Eurosceptic Marine Le Pen, and former Prime Minister under Nicolas Sarkozy, François Fillon.

Le Pen is adamant that France should not be an EU member. She advocates a return to the Franc, and pursuit of nationalistic economic and immigration policies. Many elites regard her and her daddy as soft-core Nazis. However, her brand of French nationalism continues to gain adherents.

A rejection of the Italian referendum and a win by Hofer, will increase Le Pen’s chances of victory. After Brexit, France is the second largest economy in the EU. It is obvious to see why its exit would be catastrophic for European risk assets.

Let’s Trade

The obvious trade is to take a position long or short on the Euro. After the SNB debacle, retail FX brokers learned their lesson. Spreads and fees will rise on Friday night before FX markets close for the weekend.

Bitcoin is the only asset that trades 24/7. During the weekend Greek votes in the summer of 2015, Bitcoin reacted in real-time as Greece inched closer to leaving the Euro. The events set in motion by an Italian No vote, and or a Hofer win are positive for market volatility and instability. Bitcoin thrives in these situations. As such, expect Bitcoin to creep and then explode higher if one or two of these events occur. My upside target price is $800.

Should Italy affirm the new constitution and Hofer lose, expect Bitcoin to dip. A test of $700 and then $680 is warranted as a portion of risk-off premia vacates the Bitcoin price.

Hong Kong Bitcoin Derivatives Arbitrage Seminar

I will be leading a 90-minute seminar on the basics of arbitrage using Bitcoin and cryptocurrency derivatives. This seminar is geared towards financial services professionals who want to learn how to apply standard arbitrage techniques to the cryptocurrency markets.

When: Wednesday, 7 December 2016, 6:30pm – 8:00pm
Where: Metta, 21/F California Tower, 30-32 D’Aguilar St, Central, Hong Kong
Cost: Free

Please signup here.

After the seminar, please join us at the Bitcoin Association of Hong Kong’s Blockchain Holiday Party sponsored by BitMEX at the same location. I hope to see some of you there.