BitMEX Product List Update

Quarterly Bitcoin / USD Futures Contracts

The following quarterly contracts will be listed on or before 15 December 2017 12:00 UTC:

  • BitMEX Bitcoin / USD 30 March 2018 futures contract, XBTH18

We will add the BitMEX Bitcoin / USD 29 June 2018 futures contract, XBTM18, in the near future.

Quarterly Bitcoin / JPY Futures Contracts

No new Bitcoin / JPY quarterly contract will be listed after the BitMEX Bitcoin / JPY 29 December 2017 futures contract, XBJZ17, expires. We will add a Bitcoin / JPY perpetual swap in the near future.

Quarterly Altcoin Futures Contracts

The following quarterly contracts will be listed on or before 15 December 2017 12:00 UTC:

  • BitMEX Ether / Bitcoin 30 March 2018 futures contract, ETHH18
  • BitMEX Dash / Bitcoin 30 March 2018 futures contract, DASHH18
  • BitMEX Litecoin / Bitcoin 30 March 2018 futures contract, LTCH18
  • BitMEX Monero / Bitcoin 30 March 2018 futures contract, XMRH18
  • BitMEX Ripple / Bitcoin 30 March 2018 futures contract, XRPH18
  • BitMEX Zcash / Bitcoin 30 March 2018 futures contract, ZECH18

Please note the fee structure for all altcoin futures contracts will change to maker / taker, -0.05% / +0.25%.

I’ll Take That

Building wealth is the easy part, securing and storing it for use by subsequent generations is very difficult.

Half a millennium ago, a wealthy family needed a private army to secure its land and wealth. If you couldn’t project violence in the defence of your assets, they would be forcibly taken by an opportunistic person.

As civilisations evolved and we entered the age of the nation state, society agreed that a centralised government should have a legal license to kill in order to secure the interests of property owners. Regardless of the economic “ism” a government claims to practice, the goal is the same. Protect a small group of asset holders against the hoard of commoners who might like to improve their lot at the expense of the elites.

Today the richest humans don’t command standing armies, and their holdings include financial and real assets. Stock and bond ownership relies on a central depository to affirm that you indeed are the owner. Government deed offices proclaim a piece of land or real estate is yours.

You are rich as long as the government allows you to be. The trappings of wealth can be taken at a whim. Should your actions upset a powerful state actor, your bank accounts will be frozen, and assets confiscated through the courts.

The recent Saudi corruption drive is case and point. Mohammad bin Salman (MBS), the crown prince of Saudi Arabia, is on a mission to wean the country off of oil. This is harder said than done, especially since the general population only complies because of generous government handouts. To beef up the government coffers, MBS did what all governments do, go after certain rich people.

MBS certainly wouldn’t subject himself to austerity. Last year he purchased a yacht worth over $500 million while at the same time slashing government spending.

Overnight some of the country’s richest members were herded to the Ritz Carlton, and placed under arrest owing to “corruption” charges. The most famous billionaire ensnared was Prince Alwaleed bin Talal. This Price is a world famous investor and has large stakes in some of the biggest tech darlings globally.

After a few days cooped up in the Ritz, MBS presented his chattel with a choice. Liquidate your assets and give the Saudi government up to 70%, or stay locked up. Even if a large percentage of your wealth is held offshore, due to information sharing between governments, MBS likely knows where the biggest nuggets are held. If he doesn’t think you have been forthcoming enough with the true state of your offshore wealth, well the Yemeni front line is awful fun these days.

Bitcoin presents a different way to secure wealth. Instead of trusting a government staffed with capricious humans, holders of Bitcoin trust cryptography and a decentralised network of profit motivated miners.

Bitcoin is less than a decade old, and is still very much an experiment. But if you possess a sum of wealth, it is prudent to diversify the networks used to secure it. Many people believe if they follow the “law”, they will be alright. However, laws change to serve the growth and power of the government writing them.

The government failures in Venezuela and Zimbabwe illustrate that in times of crisis Bitcoin can be used to grease the wheels of commerce. Unfortunately for most, it takes a time of crisis to elucidate the fatal flaws of a particular economic system. Only then will people take concrete actions, which only moments ago, were diametrically opposed to their belief system. At that point it’s too late.

BitMEX vs. CME Futures Guide

Bitcoin is at a watershed moment. The Chicago Mercantile Exchange (CME), the largest exchange globally by notional traded, deemed Bitcoin worthy of a futures contract. The contract will allow investors to speculate on the Bitcoin / USD price without owning Bitcoin. Prior to this contract, derivatives traders were required to own Bitcoin in order to post margin on futures trading platforms such as BitMEX.

Due to the different client bases that BitMEX (retail), and the CME (professional investors) serve, the price discrepancies between two futures contracts with the same underlying will present enormous opportunities to generate arbitrage profits. This guide will walk traders through how to execute such trades.

Contract Specs

Each CME contract is worth 5 Bitcoin (XBT), and quoted in USD. Margin and profit and loss (PNL) are denominated in USD. This is what I refer to as a linear contract structure.

CME XBT Value = 5 XBT * Contracts
CME USD Value = 5 XBT * Price * Contracts

Each BitMEX contract is worth 1 USD of Bitcoin, and quoted in USD. Margin and PNL are denominated in XBT. This is what I refer to as an inverse contract structure.

BitMEX XBT Value = 1/Price * 1 USD * Contracts
BitMEX USD Value = 1 USD * Contracts

The above chart shows the XBT value of each contract. The CME contract has a fixed value in Bitcoin no matter the spot price. The BitMEX contract’s Bitcoin value follows a 1/x function. Technically speaking the BitMEX multiplier is negative, even though in the graph uses a positive multiplier for a better visualisation.

Assume you are long 10,000 contracts at a price of $1,000.

XBT Value = 1/$1,000 * -1 USD * 10,000 = -10 XBT

Now the price falls to $500.

XBT Value = 1/$500 * -1 USD * 10,000 = -20 XBT

At a lower price, the XBT value is a larger negative number.

XBT PNL = -20 XBT - (-10 XBT) = -10 XBT

This means that the value in Bitcoin declines faster as the price falls, and increases slower as the price rises. That is negative gamma, or negative convexity.

The above chart shows the USD value of each contract. The CME contract’s USD value changes in a linear fashion with respect to the spot price. The BitMEX contract’s USD value is fixed at $1 per contract.

CME Contract Specs

Contract Size

The CME contract is much larger in notional terms than BitMEX’s. If the price of Bitcoin is $8,000, one CME contract is worth $40,000. To achieve a similar notional on BitMEX requires 40,000 contracts.

When I touch on spread trades later, the much larger CME notional means that only traders with large amounts of capital can put on these trades. This limiting factor, along with the lower leverage offered by the CME, means most retail traders will be unable to trade the CME product.

Settlement

The first major difference between the two contracts is the underlying index. The CME settles on the CME CF Bitcoin Reference Rate. This index includes prices from Bitstamp, Gdax, itBit, and Kraken. BitMEX settles on the BitMEX Index that includes Bitstamp and Gdax.

Traders who hold either contract to expiry will need to familiarise themselves with each index, and at a minimum be able to trade on all four exchanges.

Both BitMEX and the CME expire on the last Friday of the contract month. However, BitMEX expires at 12:00 UTC, while the CME expires at 16:00 London Time which is either 16:00 UTC or 15:00 UTC depending on daylight savings. Given that the expiry time differs by only 3 to 4 hours, there is little benefit to adjust the time value when computing relative basis.

Margin

Bitcoin is a call option. The more volatile it is, the more valuable the option. Due to an infinite upside, and a capped downside at 0, the trading pressure on the margin comes from longs. That means that market makers who are price neutral will usually be short derivatives. Their propensity to quote an offer depends on how easily it is to purchase spot Bitcoin, and how their short derivative is margined.

As I previously mentioned the BitMEX contract is margined in XBT. That means that shorts can purchase spot Bitcoin and use this as collateral against their BitMEX short. If you buy $1,000 of Bitcoin, deposit the full XBT notional with BitMEX, then short 1,000 BitMEX contracts, you cannot be liquidated if the price rises.

BitMEX shorts, due to the inverse contract structure, are long gamma in XBT terms. That means as the price rises, their unrealised losses increase less quickly. Therefore, BitMEX shorts can use more leverage than they otherwise would if the contract used a linear contract structure.

Contrast that with the CME, which margins the contract in USD. For a market maker who is short, their spot Bitcoin hedge cannot be used as margin at the CME. As the price rises, their Bitcoin is worth more; however those unrealised USD gains cannot be deposited as margin. The CME will demand more USD collateral as the unrealised losses mount.

This makes shorting the CME contract very capital intensive. A priori, I expect the CME contract to trade more expensive than BitMEX. CME shorts need to be compensated via a higher basis for their implicit short volatility position.

The CME intends to list a futures curve out to one year. The backend of the curve, due to a larger time value, will be illiquid when compared to the front months, and will trade at a very high basis.

I will now present two spread trades. Assume that you are a USD based investor.

Spread Trade: Long BitMEX vs. Short CME

Assume the following:

Leverage: 5x / Initial Margin of 20%

Spot = $8,000
BitMEX = $8,000
Contracts = Long 200,000
CME = $10,000
Contracts = Short 6
Spread = $2,000

First compute the XBT and USD exposures.

On BitMEX:
XBT Exposure: 200,000 Long Contracts / $8,000 = +25 XBT
USD Exposure: 200,000 Long Contracts * 1 USD = -$200,000
Margin Requirement: 20% * 25 XBT = 5 XBT
Collateral Currency Exposure vs. USD: +5 XBT / -$40,000 (Valued at the spot price)

On CME:
XBT Exposure: 6 Short Contracts * 5 XBT = -30 XBT
USD Exposure: 6 Short Contracts * 5 XBT * $10,000 = +$300,000
Margin Requirement: 20% * $300,000 = $60,000
Collateral Currency Exposure vs. USD = 0

Because you are a USD based investor, you must ensure that you do not have XBT/USD risk at any time. Due to the XBT BitMEX margin requirement, you must short an additional 1 CME contact to hedge the 5 XBT margin required on BitMEX.

Margin XBT/USD Price Risk:
BitMEX: +5 XBT / -$40,000
CME: -5 XBT / +$50,000 (Short 1 Contract)
Net: 0 XBT / +$10,000

Due to the CME’s higher basis, we earn carry on the BitMEX XBT collateral.

Spread XBT/USD Price Risk:

BitMEX: +25 XBT / -$200,000 (Long 200,000 Contracts)
CME: -25 XBT / +$250,000 (Short 5 Contracts)
Net: 0 XBT / +$50,000

As predicted, we earn $50,000 PNL from this spread trade. The below table stresses the portfolio on a large up and down move.

Price BMEX XBT PNL BMEX USD PNL CME USD PNL Total
$4,000 -25.00 XBT -$100,000 $150,000 $50,000
$8,000 0.00 XBT $0 $50,000 $50,000
$16,000 12.50 XBT $200,000 -$150,000 $50,000

The trade continues to return $50,000 regardless of the price movement. However, this is a leveraged trade, we must post additional margin on either BitMEX or the CME depending on the price move.

The below table summarises what actions must be taken to ensure we meet margin requirements.

Margin Action Currency Needed
Price Falls Buy then deposit XBT on BMEX, sell CME contracts XBT & USD
Price Rises Deposit USD to CME USD

Because we are short gamma on our long BitMEX position, we must post XBT and sell CME contracts to hedge the XBT collateral. Both of these derivatives require additional margin. On the upside, we only need to post additional USD with the CME. Depending on your cost of capital, a prolonged down move without any recovery could become very expensive.

Another issue is the sizing of this trade. Each CME contract is worth 5 XBT. If you wish to remain price neutral on your XBT collateral, a 5 XBT loss needs to be a small % with respect to your trade notional. Otherwise you will always be over and under hedged. The below table illustrates this point.

Entry Price: $8,000
Multiplier: -1 USD (for inverse contracts the multiplier is actually negative)

Contracts XBT Value Down % Move Up % Move
50,000 -6.25 XBT $4,444.44 -44.44% $40,000.00 400.00%
250,000 -31.25 XBT $6,896.55 -13.79% $9,523.81 19.05%
500,000 -62.50 XBT $7,407.41 -7.41% $8,695.65 8.70%
1,000,000 -125.00 XBT $7,692.31 -3.85% $8,333.33 4.17%
2,500,000 -312.50 XBT $7,874.02 -1.57% $8,130.08 1.63%
5,000,000 -625.00 XBT $7,936.51 -0.79% $8,064.52 0.81%

The % Move is a measure of how far the price needs to move up or down to generate a contract value change of 5 XBT. As you can see, go big or go home.

Spread Trade: Short BitMEX vs. Long CME

Assume the following:

Leverage: 5x / Initial Margin of 20%

Spot = $8,000
BitMEX = $10,000
Contracts = Short 250,000
CME = $8,000
Contracts = Long 5
Spread = $2,000

First compute the XBT and USD exposures.

On BitMEX:
XBT Exposure: 250,000 Short Contracts / $10,000 = -25 XBT
USD Exposure: 250,000 Short Contracts * 1 USD = +$250,000
Margin Requirement: 20% * 25 XBT = 5 XBT
Collateral Currency Exposure vs. USD: +5 XBT / -$40,000

In order to hedge the 5 XBT of margin required, sell an additional 50,000 BitMEX contracts.

XBT Exposure: 50,000 Short Contracts / $10,000 = -5 XBT
USD Exposure: 50,000 Short Contracts * 1 USD = +$50,000
Net: 0 XBT / $10,000

On CME:
XBT Exposure: 5 Long Contracts * 5 XBT = +25 XBT
USD Exposure: 5 Long Contracts * 5 XBT * $8,000 = -$200,000
Margin Requirement: 20% * $200,000 = $40,000
Collateral Currency Exposure vs. USD = 0

Spread XBT/USD Price Risk:
BitMEX: -25 XBT / +$250,000 (Short 250,000 Contracts)
CME: +25 XBT / -$200,000 (Long 5 Contracts)
Net: 0 XBT / +$50,000

As predicted, we earn $50,000 PNL from this spread trade. The below table stresses the portfolio on a large up and down move.

Price BMEX XBT PNL BMEX USD PNL CME USD PNL Total
$4,000 37.50 XBT $150,000 -$100,000 $50,000
$8,000 6.25 XBT $50,000 $0 $50,000
$16,000 -9.38 XBT -$150,000 $200,000 $50,000

The trade continues to return $50,000 regardless of the price movement. However, this is a leveraged trade, we must post additional margin on either BitMEX or the CME depending on the price move.

The below table summarises what actions must be taken to ensure we meet margin requirements.

Margin Action Currency Needed
Price Falls Deposit USD to CME USD
Price Rises Buy then deposit XBT on BMEX, sell BMEX contracts XBT

Because you have positive gamma on the short BitMEX position, you will not face a doubling of margin requirements when the price falls. This spread trade is more capital efficient; however, I doubt whether BitMEX will frequently trade more expensive than the CME for reasons described above.

Gap Risk

The CME does not trade over the weekend. Longs or shorts depending on the price action over the weekend, could be insta-rekt when the exchange reopens Sunday night US time.

Interactive Brokers, one of the CME’s clearing members, expressed severe reservations about this product due to the high volatility. They are scared shitless about how to deal with underwater shorts. It is not impossible for Bitcoin to gap up 100% in a matter of hours on positive news. Imagine what will happen when an ETF finally is approved.

BitMEX deals with gap risk via Auto-Deleveraging. The CME at the present moment cannot employ a socialised loss feature. Instead, clearing members must pony up the cash. That is why they are being such scaredy cats.

Depending on your broker, margin requirements for short positions could be extremely unforgiving. This will push CME basis up even further, and make putting on the spread trade described above, even more expensive.

Are You Yellow?

Arbitraging BitMEX vs. the CME requires a high level of trading sophistication and attention to detail. The different margin currencies and policies present many opportunities to transform what is a sure profit into a massive loss.

However, owing its the difficulty, these spread trades will be juicy. For students of markets, this is an arbitrage opportunity of a lifetime. Those who put in the time to perfect these strategies, will profit handsomely.

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.

Liquidity

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.

SHORT SQUEEEZZE

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.

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.

Policy on Bitcoin Hardforks (Update) and SegWit2x (B2X)

Anyone can create a chain fork of Bitcoin at any time. The possibility of a SegWit2x hardfork (B2X) in November 2017 requires that we, once again, clarify our position on any and all potential hardforks.

 

BitMEX Hardfork Policies

At BitMEX, our top priority is protecting the assets of our customers. In order for us to effectively do this, we insist that any Bitcoin hardfork includes the following:

  • Strong two way transaction replay protection, enabled by default, such that transactions on each chain are invalid on the other chain.
  • A clean break, such that the new chain cannot be “wiped out” by the original chain.
  • A modification to the block header, such that all wallets (including light clients) are required to upgrade to follow the hardforked chain.
  • A change in address format, to prevent people inadvertently sending coins to an address on the wrong chain.
  • New P2P network magic, to ensure a functioning and reliable node network for both coins.

Strong replay protection and wipeout protection, in particular, are considered absolutely crucial.  Should a hardfork not follow these policies, we will not support the new coin. To be clear, we do not intend to access or keep these coins. The administrative overhead of distributing any and all hardforked coins (including Bitcoin-based distributions like Byteball/Lumens) is prohibitive and BitMEX will not monitor or maintain balances of hard-forked coins.

Additionally, support of any forked currency is solely at the discretion of BitMEX. While we may snap users’ margin balances at the time of the fork in case we decide to distribute, there is no guarantee that it will be safe, desirable, or practical to do so. If this concerns you, you should withdraw your funds before any given fork and handle the split on your own.

 

SegWit2x (B2X) – BitMEX Policy

The SegWit2x (B2X) proposal is aimed at increasing the blocksize. It is scheduled to take place in November 2017. This change is incompatible with the current Bitcoin ruleset and therefore a new coin may be created.  

Proponents of this new coin hope it becomes known as Bitcoin, however which coin is known as Bitcoin is not up to the proponents of the new token. Investors and traders may decide which coin has the highest value.  In order for this process to work smoothly, strong two way  transaction replay protection is necessary.

It is our understanding that the SegWit2x proposal does not include two way transaction replay protection, enabled by default. Therefore BitMEX will not be able to support SegWit2x.

As such, BitMEX will not support the distribution of B2X, nor will BitMEX be liable for any B2X sent to us.  This policy applies even if the SegWit2x chain has the majority hashrate. Therefore, it is up to our users to withdraw their Bitcoin’s from BitMEX prior to the fork if they wish to access B2X.

BitMEX considers any and all contentious hardfork tokens as altcoins. The .BXBT and .BXBTJPY indices will remain unchanged and will not include B2X.

XBTUSD Funding Mean Reversion Strategy

 

After over a year in existence, it is time to analyse the predictive properties of the XBTUSD funding rate. The XBTUSD 100x leveraged contract is a Bitcoin / USD total return swap that has no expiry date. To anchor the price of the swap back to the spot market, an interest payment (we call this funding) is exchanged between longs and shorts. The interest rate by and large is determined by the previously observed 8-hour time weighted average premium of the swap vs. the spot price.

The funding rate is published with an 8-hour grace period before it is charged. That allows traders who do not wish to pay or receive funding to exit their positions before the funding timestamp. The question is, can you predict the future price of Bitcoin by the published funding rate?

I have analysed data from March 2017 until now. My data series consists of the funding rate every 8 hours, and the log return of the XBTUSD swap over the next 8 hours.

T0: Now
T1: 8 hours in the future

X-axis: Funding Rate published T0 to be charged at T1
Y-axis: Log(XBTUSD P1 / XBTUSD P0)

Simple Regression

The above chart is a XY scatter plot of the data. The chart clearly illustrates the funding rate contains no significant predictive power.

Digging Deeper

When the funding is extremely positive or negative, this could signal a reversal in the market’s direction i.e. mean reversion. Using an extreme funding rate as the signal, we can take the counter trend position.

Example:

If the published funding is at the maximum +0.375%, does that predict with greater accuracy whether the return of XBTUSD in the next 8 hours will be negative?

To further analyse this hypothesis, I calculated the sample mean and standard deviation of the funding rate in basis points (bps).

1bps = 0.01%
Mean: 1.66bps
Standard Deviation: 17.13bps

I constructed one and two sigma bands. I then conducted mean reversion tests.

1 Sigma = 1 Standard Deviation

Hypothesis:

A large negative funding rate predicts a positive return for the next 8 hour period. A large positive funding rate predicts a negative return for the next 8 hour period.

The magnitude of the funding rate tested depends on the number of sigmas away from the mean.

The following table lists the results.

Sigmas Funding Rate Sample Size % Success Cumulative Funding Cumulative XBTUSD Return Cumulative Return % of Total Observations
-2 -32.61 21 47.62% -7.71% 3.36% 11.07% 4.01%
-1 -15.47 62 53.23% -16.76% -18.15% -1.38% 11.83%
1 18.80 81 45.68% 25.10% -14.77% 10.33% 15.46%
2 35.93 36 44.44% 13.49% 6.90% 20.39% 6.87%

Sample Size – Out of 524 funding periods, this is the number of times that the funding rate was less than or equal to the sigma adjusted test (assuming a negative funding rate).

% Success – Out of the sample size, this is the number of times where the funding rate was negative and the next period return was positive or vice versa.

Cumulative Return – This is the net return, including funding, of both success and failure situations. If the funding rate is negative, you go long, and you receive funding because the rate is negative. If the funding rate is positive, you go short, and you receive funding because the rate is positive.

% of Total Observations – Sample Size / 524 (Total Number of Funding Periods)

Conclusion

The data clearly illustrates that traders may use an extreme funding rate as a signal to take the counter trend position. The added benefit of receiving funding for bucking the trend is what provides a significant majority of this strategy’s returns.

A simple trading algo can be constructed to capture this alpha. At each funding timestamp, if the funding rate is above or below your limit, place the counter trend trade. Immediately after the next funding timestamp, close your XBTUSD position.

The one caveat is the sample size is still relatively small. I will revisit this study early next year to observe if the results change.

 

The Big Bad Wolf

This week the PBOC decreed that its plebes may not invest or trade Initial Coin Offerings (ICOs). However when one engages in critical thought, it appears this ban has more bark than bite. Examining the way in which the ban was presented to the public, and the actions that were not taken, leads me to believe that this ban is for publicity only.

What Is Banned

ICOs are considered an illegal form of financing by the PBOC. Exchanges must stop supporting any trading of the tokens. Almost immediately most of the Chinese ICO trading platforms shut down. Over the past few days, many exchanges delisted any tokens from their platform. As you can imagine, without the cannon fodder of retail punters, token prices initially collapsed.

Projects that raised money from Chinese nationals must refund them their Bitcoin or Ether. Since in practice, this is impossible to accomplish, the PBOC now has a nice excuse to shut down any exchange it wishes for violating the law.

Token exchange owners must take their butt finessing with a smile on their face. They must bend over again when asked, or the PBOC will find them in violation of a law that is impossible to abide by.

Similar to the large exchanges that deal with RMB to Bitcoin or Ether trading, the PBOC now has token trading platforms firmly under their control. That is the primary reason for these new regulations.

What Is Not Banned

The PBOC might have banned the issuance and trading of ICOs in China; however, they did not outlaw the way in which ICOs are funded. The revolutionary aspect of ICOs is that the money raised is in the form of a non-governmentally aligned currency. Usually that is Bitcoin or Ether.

If Chinese punters can still convert RMB into Bitcoin or Ether legally, and withdraw their digital currency from the exchange, they can still subscribe for any ICO they wish. Once the trader’s assets are purely in the crypto space, it is very difficult for the PBOC to control where that money goes.

The PBOC isn’t stupid. They are very informed on how money flows into and out of ICOs. Therefore, this was a deliberate omission from the new ICO regulations. What the PBOC did is construct a beautiful piece of PR.

The PBOC demonstrated that it cares about the wellbeing of retail investors. The PBOC has prevented investors from losing money in this risky and volatile new asset class. If the PBOC really cared about the financial health of China it would stop propping up the property market by continuing to allow banks to issue credit. But that will never happen, so another industry was targeted to prove their good intentions.

By allowing the big three exchanges to continue business as usual, the PBOC is allowing the ICO market to limp along in China. The high priests recognise that a vibrant ICO market in China is valuable. It helps promote entrepreneurs to create the next wave of useful technological applications that could propel China forward.

The National Congress

The 19th National Congress of the Communist Party begins in October. Every aspect of life in China is affected by this pow-wow. Xi Jinping must present a country that is chugging along towards greatness. No outward crack in the veneer of harmony and prosperity is allowed.

The once vibrant ICO industry in China was a liability. The amounts of money raised grew and grew, and the risk of a high profile project absconding with hundreds of millions of dollars could not be ignored. The last thing Beijing needs before the all-important National Congress is a horde of destitute punters protesting about losing their money in one or more shitcoins.

One day after the ban, CCTV ran a piece about the cessation of ICO trading in China. They claimed that 60 ICOs raised 2.616bn CNY, across 47 platforms, involving 105,000 investors. The highly coordinated nature of the announcement and than a prime time television piece about the new regulations is good theatre. Insecure governments will create good theatre in advance of important jamborees. The plebes must feel the love.

The Future, BTFD!

The crypto market does not respect the PBOC like it once did. Bitcoin and Ether declined 15% and 20% respectively immediately following the ban. However, both have almost paired Monday’s losses. To many traders, this ban presented a perfect opportunity to increase their exposure to the asset class.

While the PBOC banned ICOs, it did not address the root cause of why Chinese investors are desperate to hand their savings to teams with slick websites. The property market is still too expensive for most traders, and after the 2015 carnage, many traders avoid the A-share market. The PBOC continues to allow domestic banks to expand the money supply through aggressive lending. This unabashed money printing creates a fear amongst comrades of a massive upcoming devaluation of the RMB. Any asset or scheme that can generate inflation beating returns excites desperate Chinese savers.

After experiencing a modicum of freedom over the investment of their savings, Chinese investors will chafe under these new regulations. The forbidden fruit tastes sweeter. By banning ICOs, the PBOC just created the industry’s best marketing tool.

The ICO asset class is still very niche. But now that CCTV is educating everyone in China about what they are. More people will attempt to purchase this taboo asset. Far from negative, this is one of the best things that could happen to any alternative asset.

ICO fundraising in China will move underground. After the National Congress, the restrictions on ICO fundraising will loosen. Remember the “crackdown” on the big three exchanges earlier this year. After a few months, the PBOC relented and allowed trading and withdrawals to function normally again.

Savvy offshore trading platforms will profit from the gap in the market caused by the closure of the leading onshore Chinese trading platforms. While overt fundraising through WeChat and QQ groups will cease for now, motivated ICO promoters will create innovative ways to access the insatiable demand for alternative savings products from Chinese investors.