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 bytes, to ensure a functioning and reliable node network for the 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.


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


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)


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.

Push It

The hard fork came, went, and now we are much better for it. Depending on who you ask, Bitcoin Cash is a roaring success or failure. Traders are neutral beings only concerned with generating profit. The fear, greed, and widely different policies enacted by exchanges offered juicy arbitrage opportunities.

Bitcoin Cash was not the first altcoin to enter existence through a hard fork of Bitcoin. However, it was the first to be widely publicised. Even the New York Times wrote decent articles explaining what Bitcoin Cash was, and what it could mean for Bitcoin.

Even though SegWit is activated, the scaling debate is not finished. Later this fall, it is extremely likely that Bitcoin will hard fork again. A version of Bitcoin with SegWit and a 2MB block size (SegWit2x) will begin trading. Therefore, traders should learn about how to make money using derivatives before, during, and after a hard fork.


I will use the example of Bitcoin (XBT) and Bitcoin Cash (BCH) in this theoretical example.

A hard fork of any digital currency is akin to a stock dividend. There is a finite amount of network hash power at any time. Miners will decide which version of a coin to mine based on the price ratio. The difficulty will then adjust to bring the ratio of hash power and price into equilibrium. Price leads difficulty adjustments.

1 August 13:17 UTC was the record date for BCH distribution. If you held XBT on that date, you theoretically were entitled to BCH in a 1:1 ratio. If you purchased Bitcoin after the record date, you did not receive BCH.

After the record date, a stock goes ex-dividend. The stock price will drop by the dividend that is paid. If we believe that hard forks act like dividends, then XBT went ex-div on August 1st. XBT should have dropped by the value of BCH.

In practice, because price leads difficulty adjustment, it isn’t necessarily true that XBT will or should drop immediately by the value of BCH. Additionally, unlike stock dividends which are a discrete amount of cash, BCH is a tradable currency and its value fluctuates.

Holders of long futures contract do not receive dividends. Therefore a futures contract should trade at a discount relative to the expected dividend payment. If it doesn’t, arbitrageurs will buy a stock and sell the future. They will receive the dividend payment from their long stock position, and if that is greater than the futures discount, they make money.

The same phenomenon should occur in the Bitcoin futures markets. BitMEX decided that our XBTUSD and XBTU17 products underlying index would not include the value of BCH. Traders who wished to create BCH without any XBT price risk bought XBT, then sold the USD equivalent number of swap or futures contracts, and then receive BCH. Note, they would not receive any BCH for XBT margin held on BitMEX.

XBTUSD and XBTU17 theoretically should trade at a discount relative to the value the market places on BCH. The big difference with BCH is that the future price is unknown.

Pre-Fork XBTUSD and XBTU17 Behaviour

The above chart is the outright % discount of XBTU17 from July 30th to August 3rd. The chart illustrates that traders attempting to create BCH without market risk drove the futures into extreme backwardation. The discount reached almost 5% hours before the record date.

The above chart is the outright % premium or discount of XBTUSD during the same time period. Traders also sold XBTUSD to create BCH. The swap was backwardated, which resulted in shorts paying longs funding. Over this time period shorts paid 3.51% of funding. Remarkably the swap reached an outright 3.52% discount hours before the record date.

The following trades assume you have no view on the viability of BCH. BCH may or may not be successful, but the trades I will describe yielded predictable positive returns. The trades described also have no Bitcoin / USD price risk.

Trade 1: Buy XBTU17 vs. Short XBT Spot

Predictably interest rates to borrow Bitcoin spiked during this period. Borrowing Bitcoin during the eye of the storm is not advisable. Prudent traders should have credit lines in place well in advance of the event. That allows them to lock in much cheaper rates.

Using the above chart as a guide, putting this trade on hours before the fork yields the best returns. That is when traders are the most irrational. The best part is that the basis will mean revert quickly, and it did, after the fork. Therefore you limit the amount of time you pay to borrow Bitcoin.

Assume you paid an egregious 1% per day to borrow Bitcoin. XBTU17’s discount went from 5% to 1% in 24 hours. Therefore, you could have earned 3% in one day on this trade.

Trade 2: Buy XBTUSD vs. Short XBT Spot

Again the best time to put this trade on is hours before the fork. The beauty of funding is that for the rate to go from negative to positive, the swap must go from trading at a discount to a premium. Therefore you get paid twice.

You capture the full discount, plus when you exit, the swap will be at a premium. While the swap basis mean reverts, you also get paid interest every 8 hours for being short. Once the published rate is positive, you close you long at a premium. After August 1st, it took a subsequent ten funding periods before the rate was positive again.

Post-Fork XBTUSD and XBTU17 Behaviour

The fork is over. The community breathes a sigh of relieve and hedges must be unwound. Any trader that created their BCH now has it, and must close short derivative positions. The problem is that if Bitcoin rallies alongside the unwind, basis will rise, and hedgers will be forced to cover at much higher premiums.

A priori we know the short squeeze will be violent. Therefore it is prudent to go long basis after the record date.

The above chart is the XBTU17 outright % premium from August 3rd to 8th. The massive jump in premium occurred as the price broke $3,000. Remarkably traders were given an opportunity for days following the fork to buy XBTU17 at a discount. Those that did are test driving Lambos while you ride the bus.

The above chart is the XBTUSD outright % premium over the same time period. The spike in premium occurred as the price broke $3,000. During that same time period, the funding went from negative to positive. In total, shorts received 1.76% of funding.

Trade: Buy XBTU17 vs. Short XBTUSD

The aim of this trade is to play the mean reversion of XBTU17 basis. Hedgers on the margin will choose to short the future to create BCH because the interest rate they pay via the discount pre-fork is fixed. As opposed to XBTUSD which has a variable interest rate, and cannot be known a priori.

Therefore XBTU17 basis will go from negative to positive. As the XBTU17 basis mean reverts, XBTUSD’s funding will shift from negative to positive. You benefit from a rising XBTU17 basis, plus your short XBTUSD hedge also receives interest income every 8 hours. Booyakasha!

SegWit2x Hard Fork

Bitcoin Cash was a warm up for the main event later this year. Both the big blockers and SegWit disciples believe their cause was vindicated by the recent hard fork. Big blockers point to the non-zero value of BCH as proof the market values their scaling solution. SegWit folks point to the high and rising price of Bitcoin as proof that the market values their scaling solution.

Neither side will back down before the SegWit2x hard fork put forward in the New York Agreement. The Fear Uncertainty and Doubt (FUD) surrounding the SegWit2x hard fork will be deafening.

This FUD will put a lid on the Bitcoin price. $5,000 will not be broken until after the hard fork occurs. This sets up an exact replica of the Bitcoin Cash hard fork with more money on the line. The trades and scenarios described above will remain relevant in a few months time.

I Ain’t Yo Daddy

This July the BitMEX team absconded to Milwaukee, Wisconsin for a team offsite. Milwaukee in the summer is beautiful. I thoroughly enjoyed morning runs on the banks of lakes and rivers in clean, crisp, and dry air. I’m currently training for Winter squash season in Hong Kong. Anything that makes keeping to my cardio schedule easier is appreciated.

One day at lunch Ben and his wife wanted to eat oysters. They left the table and returned shortly afterwards. Ben recounted how they attempted to purchase oysters, but due to a silly regulation, they had to be seated, served, and supervised while eating them. There was a long line for table service so they were unable to consume anything.

The nanny state is alive and well. Two adults cannot be trusted to put a shell to their mouth and slurp a morsel of food. Instead, they must be supervised by another human, and pay tips and tax for that privilege.

The infantilization of the global population shows no signs of abating. The government injects itself into every aspect of our lives, and in most cases we are worse off for it. Bitcoin in some respects is a reaction against this trend.

Bitcoin and the digital currency industry empowers adults to take control of their financial well being. This is liberating, but it comes with costs. Adults are expected to make informed decisions by ingesting all available information. Adults make their own good and bad choices. There is no CEO of Bitcoin to tell adults how to behave, where to trade, protect them if they lose their password, or police trading venues.

Some Bitcoin traders live by this ethos of personal responsibility. However, many of these same traders express concern that Bitcoin markets do not operate like other regulated asset classes. In a recent Medium article entitled “Meet ‘Spoofy’. How a Single entity dominates the price of Bitcoin.”, the author rants and raves about how a trader or group of traders are spoofing and distorting the market. The author does present interesting allegations about Tether; however, that rabbit hole is best addressed in another newsletter.

I wholeheartedly do not wish Bitcoin to trade like traditional assets. Traders should be free to, well trade. I will detail certain market practices, and why I believe they pose no threat to the integrity of the Bitcoin markets.

Insider Trading

The job of a trader is to have better information than the market. That is the textbook definition of insider trading. Traders who do not use inside information will not make money.

Insider trading is most policed in the equity markets. The reason why there are discontinuous jumps in the price of stocks is that information is held back from the market. If all available information could be traded upon at any time, trading patterns would be smoother.

American regulators are the most aggressive prosecutors of insider traders. The irony is that US congressmen and women are allowed to insider trade on companies which they essentially regulate. That creates an interesting love triangle.

Companies lobby (aka bribe) lawmakers about regulations. The lawmakers know that certain decisions they make will positively or negatively impact the stock price once made public. These same lawmakers then trade on this information and earn above average returns.

Excessive regulation and legalese provide a defensive moat for large companies against small ones. The cycle perpetuates itself because only large and well heeled companies can afford the cost of continuous bribery. This bribery presents a much better return on investment than improving their underlying product.

Lawmakers receive cash on both sides of the equation. Their reelection campaigns are funded by big business, and they get to trade the stock ahead of important regulatory changes. A variant of this triangle is present in most heavily bureaucratic governments.

Bitcoin trading occurs across a set of unaffiliated exchanges and various jurisdictions. The notion of what could constitute inside information is difficult to discern. Given the lack of a generally accepted theory on the fundamental value of Bitcoin, a piece of market news has positive or negative implications depending on who you ask.

In the ICO and altcoin markets, knowledge about potential partnerships, software bugs, or completion of certain development milestones before the general public can provide immense profits. The traders who invest the time speaking with the developers and are active in the community, are the traders who make the most money.

What a thought, if you put more effort into your craft, you make more money.


Spoofing is illegal on most regulated exchanges. Spoofing is the act of posting a order you do not have the intention of honoring. Spoofing is bluffing.

I find it incredible that this is illegal in certain markets. If you wanted to buy $1 billion worth of Bitcoin right now, would you tell the market? No. A smart trader would bluff that they wished to sell $1 billion worth of Bitcoin, and then if the market believes him and trades lower, buy at a lower price.

If a trader has the collateral needed to place an order, he or she should be allowed to place that order. Whether or not he intends to get filled is irrelevant. The big problem, however, is if the exchange violates price -> time priority in order to let the spoofer get off the hook, if a legitimate trade occurs based on their price.

Rather than focus on the flashing of large orders on Bitcoin exchanges, the author of the above mentioned article should focus on whether price -> time order matching priority was violated.

Speaking for BitMEX, price -> time priority is sacrosanct. We have never, and will never violate this essential law of order matching.

Many point and click traders believe that the mythical market makers on most Bitcoin exchanges are allowed to violate price -> time priority. The human trader sees a price, they think about it, then place a manual order. The order they thought would be instantly filled is not. Now the market has moved away from them. They cry foul. They believe their order should have been filled, and somehow the market maker was able to get out of a valid trade.

At BitMEX order matching is done atomically. If your order submission creates a match, there is no way a market maker can pull their quote before being filled. I reiterate, price -> time priority always holds at BitMEX.

Point and click traders must recognise that the human eye to brain to motor function loop is extremely slow when compared to a trading robot. You are slow, but the exchange in most cases is not at fault.

If you cannot accept your inferiority as a human, either trade with a robot, or trade using a higher time frame.


The most successful Bitcoin exchanges have the most pristine reputations. There is no deposit insurance or global Bitcoin trading cop to run to. If you do not approve of the way an exchange operates or their business practices, you are free to leave the platform at any time.

In order to retain customers, exchange operators must cater to their users. Contrast that to traditional asset markets. Financial institutions fluff regulators rather than improve the experience of their paying customers.

Reputations take forever to build, and are tarnished instantly.

Regulatory agencies can be bought, and most are held captive to the industries they police. Most high level jobs at financial institutions are held by ex-regulators. There has to be a pot of gold at the end of the rainbow to entice capable individuals to accept government jobs that pay less than the private sector.

Adults trading digital currency markets have extreme power to shape the collective trading experience. A tweet or reddit post from a KOL greatly impacts the perceived safety and integrity of an exchange. Adults should use this power to create a trading environment that is conducive to safety and wealth generation.

The above mentioned Medium article is a great example. The mainstream financial press picked up on this and amplified the reach of the author’s views. These views are not kind on many of the exchanges mentioned in the post. This surely will drive business to other outfits who, rightly or wrongly, are deemed to be honest.

The court of public opinion is the best motivator.

Day Traders

If you cannot devote at least 12 hours per day in chat rooms, on message boards, and constantly monitoring your positions, do not day trade digital currencies. Trading with a less than 1 week time horizon is dangerous if you cannot devote yourself to being on call 24/7.

This is a market for adults. Be an adult, educate yourself, and in the process obtain true freedom.

Pay to Play

Chinese Miner: I would like to build a new mine in China.

Beijing: Well Sheeeeeeit. Partner, you’re gonna have to pay to play.

The recent actions by Chinese authorities to stymie the growth of Bitcoin reminded me of John D. Rockefeller’s quest to tame the infantile oil market. Rockefeller was able to exert god-like control over the oil industry because he eradicated wildcatters.

Wildcatters were small outfits that drilled oil wells wherever they could. They were not organised, and this chaotic drilling reduced the lifespan of oil patches and caused intense volatility in the price of oil. The ways in which Rockefeller culled the wildcatters earned him the title of a Robber Baron.

The Chinese government and Rockefeller have many things in common. The Chinese government wants to control every aspect of the economy. When a new sector emerges, they allow fierce competition. Once a few winners have emerged they decimate the small fish, and present the survives with an offer they can’t refuse. Pay to play, or die.

The payment can be in many forms. But essentially Beijing can tap dat ass whenever it likes, and you better smile during the session. The Bitcoin mining industry is no different.

Local governments all vie to post earth shattering growth numbers every quarter. They will do anything in their power to achieve growth. Success guarantees a seat at the table in Beijing, and riches for your family.

For this reason, as well as overinvestment in aluminum production capacity, many poor parts of north western China have an abundance of electrical generation capacity. The boom in Bitcoin mining meant that anyone with capital and some connections at the local government level could profitably mine Bitcoin. Read the BitMEX Research report titled Mining Incentives – Part 2 – Why Is China Dominant in Bitcoin Mining, for a more indepth discussion of this topic.

The Chinese mining industry is dominated by a few large pool operators and miners. However, there are scores of smaller mining outfits. Beijing has little visibility into many of the smaller outfits. That could not continue forever.

A recently leaked document outlines how Beijing may block the propagation of Bitcoin blocks via the Great Firewall (GFW). Many correctly pointed out that miners could easily evade these measures through the use of VPNs. I brought this up with a laowai mining friend of mine during the recent Bitkan conference. He said that the use of a VPN or other means to evade the GFW would slow down the broadcast of your successfully mined block to the point where someone else would beat you to the punch.

In his opinion, these actions will kill all small mining outfits. The big boys can afford direct lines that bypass the GFW. Beijing sells these lines to compliant comrades, and can monitor all traffic. The fees paid are akin to a bribe to the government to continue operation. Absent this, you will be too slow to compete internationally. Now Beijing has complete control over the success or failure of your business, and you will pay whatever they ask.

He further added:

For instance, Inner Mongolia has relatively low population and economic growth. No one wants to move there. A few years ago the local Inner Mongolian government offered Chinese companies large pieces of land if they moved operations from other provinces. Each company who moved there actually got two titles, one for building manufacturing facilities and the other for strip mining coal.

The companies could cheaply and easily mine the coal for sale or build their own smaller coal power plants to run their operations. This led to a staggering amount of coal power plants in Inner Mongolia, most of them fairly small, around 50 to 250 MW.

After these companies moved there they were hit by the global slowdown in the commodity industry. Almost everyone of these factories started mining Bitcoin on the side. They write off miners as an equipment expense, and use the higher electricity usage costs to lower corporate profit and tax. In return they get a consistent side revenue that is not taxed.

While Bitmain is certainly the biggest miner in China, it by no means dominates. The vast majority of factories in Inner Mongolia and neighboring provinces are all doing this and collectively represent a significant amount of hash power.

I think this is the most likely the reason for the mainland crackdown on mining as all these factories are avoiding tax and laundering profits. By shutting things down at a network level that will force a greater centralization, the large players will then get licensed, and the government can regulate and tax them. In my opinion I don’t believe mining will be dead in China, I think it will become a permissioned industry.

The 21 million Bitcoin question is whether Beijing would use its new power to attempt to kill Bitcoin. Given that many local governments and senior members of the party profit from the continuation of mining racket, I believe the status quo suits Beijing.

Beijing’s treatment of the internet is an apt comparison for how I believe they will treat Bitcoin. Beijing tolerates the existence of VPNs, and sells private lines to bypass the GFW to certain organisations. Operation of a VPN seems cheap and easy to many readers; however, the vast majority of the Chinese masses are too poor to purchase a VPN, and more importantly have no desire. They are perfectly content with the China intranet, and have no desire to escape.

Beijing has no problem with the wealthy elite enjoying a few freedoms, as long as the mindset of the masses is not poisoned. A prime example is the job of a friend of mine in Shanghai. He re-taught elite Chinese students slated to study abroad the correct version of certain historical events. China has no problem with the masses being ignorant, but they don’t want their best and brightest to appear stupid vs. their international peers.

The recent closure of exchanges, banning of ICO fund raising, and the probable disruption of the Bitcoin network by poisoning block propagation, ensures that the masses may not enjoy the fruits of cryptocurrency, but the wealthy few can.

Time will tell whether Bitcoin and other cryptocurrencies present a real value proposition to the Chinese masses. If cryptocurrencies are like water, they will reach the lowest point given enough time. If they are not, then a small percentage of Chinese investors will continue to trade, invest, and use the technology.

Haters Gonna Hate

Why do we, as an industry, look for validation from the finance industry we are trying to disrupt? It’s difficult for most to ignore statements from two of the most powerful financiers of our age: Jamie Dimon of JP Morgan and Ray Dalio of Bridgewater.

Jamie felt the need to distract the crowd away from his bank’s disastrous quarterly trading revenue results by launching a diatribe on Bitcoin. He called it a fraud and said he would fire employees who traded it. Ray said that Bitcoin was in a bubble because it provided no utility; it is too volatile to be used as a currency in everyday commerce.

One of the most common criticisms of Bitcoin is that it is too volatile to be used as anything but a tool of speculators. Bitcoin cannot be a store of value like gold because its value fluctuates too wildly.

But why is gold put forward as the epitome of stability? Yes, it has over a thousand years of history as the symbol of wealth and international commerce. However, at one point in time using gold as a currency was revolutionary and possibly heresy.

A Gold Thought Experiment

Imagine yourself part of a early human civilisation thousands of years ago, before gold was accepted as money. Your tribe or village uses shells as money. The shells are sufficiently rare that they hold value. They are easily recognised and hard to counterfeit. However, it is hard to store the shells in vast quantities, and over time the shells degrade. Carrying a large quantity of shells is also quite difficult. Elon Musk hasn’t been born yet. Few of these shells are self-driving.

One day you discover specks of a yellow metal. Its lustre entices you to pick up a few small rocks and study them. Unlike many rocks and metals you deal with, gold is quite soft. Over a hot fire, you melt some of these gold nuggets together and find it is quite easy to work with this new metal.

The next day you tried to remember where you discovered the gold. After a few weeks of searching you were able to locate another few nuggets. Another thought: perhaps gold is rare.

As a civic-minded person, you arranged a meeting with the village leaders and showed them your new discovery. You asked if possibly gold could replace shells as the accepted currency. They laughed at you. A gold rock as money, how silly. Everyone knows that shells are money, and shells will always be money. You feel deflated but not defeated.

Yet – a woman at the meeting thought the gold would make good jewelry. It was very shiny and looked much better than the drab trinkets townspeople wore. She asked where you acquired the gold and if you could help her fashion it into jewelry.

You were able to find a location where if you dug, gold appeared fairly regularly. It was a hit. Everyone loved their new gold jewelry, it looked much better, and it held its form over time.

Given the primitive tools at your disposal, it was very difficult to find large quantities of gold. Gold jewelry began to function as a proto currency. Those who wore it were richer, as it required more and more shells each year to purchase a standard bauble.

At this point the village elders began to worry. Their wealth was stored in the form of shells. In the face of a better monetary instrument, gold, the shells depreciated in value every year. Even worse, because gold is rare, inert, impossible to counterfeit, and easy to transport, some merchants preferred to sell goods for gold rather than shells.

Because the village had a limited history handling gold, its value fluctuated wildly. No one know what it should be valued at vis-a-vis real goods and services so it still wasn’t as stable a monetary instrument as shells. The elders used this fear and price volatility to warn the plebes not to consider gold as money. Why should gold be money, it was just a shiny rock used for beautification purposes.

Overtime the village could not ignore that gold and metallic monetary instruments in general were technologically superior. Slowly then quickly, the value of gold vs. real goods and services skyrocketed. Those who had “invested” in gold, saw their purchasing power increase dramatically as the society switched to a better monetary technology.

Monetary Transition

From barter, to commodity money (gold), to paper fiat money, to cryptographic money, each one of these transitions features extreme volatility then stability. The new form of money at one point will not be able to purchase any goods and services, then all of a sudden its purchasing power increases quickly. The network effect ensures that the transition between different forms of money is chaotic.

A monetary instrument can only have value if a sufficient percentage of the network will price their goods and services in said instrument. However, no one wants to be first. The chicken and egg problem of monetary adoption ensures that once the switch happens it occurs quickly.

For savvy speculators, properly positioning oneself in front of a monetary shift is extremely profitable. Because money has no value without its network, it essentially goes from being worth nothing to something. Bitcoin is no different.

From Zero to Pizza

Bitcoin Pizza Day (May 20th 2009) is the first time Bitcoin was exchanged for a real good. Since then, as the network grew and people valued the characteristics that make Bitcoin a possible monetary instrument, its price vs. real goods and services increased dramatically.

If Bitcoin were not volatile then we would not be experiencing a monetary system transition. As traders, investors, and speculators participating in such a transition is the privilege that most humans will never experience given their infrequency.

Monetary transitions are zig zags not straight lines. Also these transitions take time. No monetary instrument completely replaced its predecessor in under a decade. Therefore it is foolish to pooh pooh Bitcoin because of volatility that is entirely due to a phase shift in monetary instrument preferences of a society.


Becoming the CEO of a multinational bank is incredibly difficult. CEOs like Jamie Dimon dedicated their lives to the organisations they lead and have made many personal sacrifices. Being human, it must irk them that youngins have become worth $100 million plus in a few years due to a belief in a different way of transferring value.

It also is annoys senior financiers that these same pups’ stated goal is to dismantle the monetary system that they sacrificed everything to lead. The smart financiers are busy buying crypto assets while they publicly deride them. The dumb ones double down on the supremacy of central bank printed fiat denominated assets.

The world is more connected than ever. A move from analog to digital cryptographic money will be chaotic and volatile. I consider myself lucky to be alive, and fortunate to be able to stake my personal fortune betting against the old and for the new.

XBTU17 Basis Forecast

Figure 1. Annualised % Premium against time to expiry

In less than 6 weeks, XBTU17 will expire. Looking to the XBTM17 historical basis helps frame a prediction on how XBTU17 could trade over the next month until expiry.

The above chart plots the annualised basis from the time each futures contract became the on-the-run quarterly contract until it became off-the-run. On 15 September 2017, XBTZ17 will list, and will become the on-the-run quarterly contract. Liquidity will gradually migrate from XBTU17 into XBTZ17.

XBTU17’s annualised basis trading range is much tighter compared with XBTM17’s. The below table lists the max and min annualised basis for each contract.

Table 1. Basis for XBTM17, XBTU17 and XBTM17 t = matching length of current XBTU17 contract

Max 122% 63% 29%
Min -46% -9% -14%

With a few weeks remaining, basis traders have a few decisions to make. These decisions depend on their views on the spot price of Bitcoin.

Late Stage Rally

Basis tends to spike when the market breaks through a major upside resistance level. XBTU17 basis spiked when spot cracked through $3,000. The next major level is $5,000.

If you believe that spot can rise that high before expiry, go long XBTU17 basis into the rally. Once $5,000 is conquered, reverse directions, go short, to put on a cash and carry arbitrage position.

On the long side, this trade profits from a rise in basis from the current sub 20% p.a. to an upside target of +50% p.a.

On the reversal, this trade profits from earning positive carry by shorting XBTU17 at +50% p.a., and holding until expiry.

Range Bound Trading

The diminishing amount of XBTU17 theta remaining means that the basis volatility will fall. Unless there is an explosive rally or correction, the basis will not move aggressively in either direction, but rather slowly diminish into settlement.

Traders should take advantage of the positive basis, and short XBTU17, placing themselves in a cash and carry arbitrage trade. The short XBTU17 position is held until expiry.

Late Stage Correction

Given the underlying bullishness of the market, dips will be bought. Large XBTU17 % discounts will not persist for very long as bottom feeders load up on cheap Bitcoin long exposure.

If such a situation does occur, the previous Range Bound Trading scenario trade recommendation can be closed out early in profit.

Everyone’s Doing It

CNBC anchors are now shilling shitcoins they just heard about last week only because of their violent price rises. The S&P 500 has performed tremendously since 2009, however, volatility, trading volumes, and general investor interest has collapsed alongside a secular bull market. For those who make their money in financial media and advice, volatility is needed.

Volatility is the lifeblood of traders and digital currency markets. While the usefulness of Bitcoin in everyday commerce is limited by volatility, it captures the attention of traders.

Figure 1. 30day Realised Vol (LHS) vs. XBTUSD (RHS)

Figure 2. 30day Realised Vol (LHS) vs. ETHUSD (RHS)

The two charts above plot the 30 day realised volatility of Bitcoin and Ether against its USD value from June 2016. A linear regression of the realised volatility against the USD price produces a positive correlation of 66% and 48% for Bitcoin and Ether respectively.

It is clear that higher volatility correlates with a higher price. Digital currencies are call options. The greater the volatility, the more valuable the option. If you desire a non-volatile store of value, try gold. Unfortunately, gold isn’t up 30x on the year.

Observing the charts, Bitcoin and Ether were much less interesting this time last year. Those who scoffed at the digital currency complex because of the high volatility back then look even sillier today. Traders and investors crave volatility. Volatility creates opportunities for differences of opinion. Volatility creates headlines, which brings new players to the game.

The Hedgies Are Coming

The intense upside volatility creates an environment where investors are finally excited about investing again. Bloomberg recently ran a story about an ex-Harvard endowment fund manager who is starting a digital currency hedge fund in Hong Kong. Another Bloomberg piece profiled the new $100 million crypto hedge fund founded by a former Hong Kong art dealer. Like moths to a flame, enlightened fund managers are hopping on the next train to 2 and 20 riches.

I receive linkedin messages daily from newly minted fund managers on the crypto haj through Asia. Many of these newbies come from legacy financial institutions. In most cases they have commitments for $5 to $25 million.

One thing many managers convey to me is how much easier it is to raise money for a digital currency hedge fund. While the AUM is much smaller at this stage, investors will gladly hand over their money even after you inform them it is entirely possible that they will swiftly lose every cent.

An AUM Thought Experiment

A properly structured hedge fund takes somewhere between 60 to 90 days to set up. As always, lawyers and banks must be greased. That costs between $50k to $100k depending on the jurisdiction and the complexity of the structure.

Most of the funds I have met contain a money man and an ideas man. The money man possesses a Rolodex of wealthy people and the pedigree necessary to separate rich people from their assets. The ideas man has a trading background, and will be the one formulating and executing trading strategies.

These individuals were earning mid to high 6-figure salaries at traditional banks, hedge funds, and or asset management firms. Even though they will take a pay cut to enter this new field, they will still draw decent salaries. Budget $300k per annum combined for their salaries.

On the technology side, depending on the strategies employed, the fund must have wallet security and trading technology. Assume this costs $100k per annum. This figure can easily balloon if the fund aims to execute algorithmic strategies. That will require a CTO with financial services experience. Anyone good is going to either want a serious cut of the equity or beaucoup d’argent.

Now, don’t forget the accountants. Managing OPM requires periodic audits by accredited firms. I hear Friedman LLP is quite excellent. Budget another $100k per year for these services.

Setup Costs: $100k
Yearly Operating Costs: $500k

Like most hedge funds, the crypto managers will charge 2% of AUM and 20% of returns. To cover the $500k operating costs at a minimum requires a $25mm AUM. If you can’t raise that amount of money, you shouldn’t attempt to raise a fund under traditional legal structures and from accredited investors.

That does not mean sub-$25mm funds do not exist. These small funds will take money from friends and family of the principles, and will not feature the same rigour surrounding legal structure and audit.

Anecdotal reports point to over 100 funds globally being formed this year. The FOMO began in earnest this summer. That means by this fall an estimated $2.5bn will need to find a home in one or more digital currencies.

The vast majority of dry powder will deploy into Bitcoin and Ether. Their combined market cap is $100bn. Many of the current holders are not selling. In the face of a $2.5bn tidal wave, marginal sellers will begin to demand higher and higher prices. Marginal buyers who engage in similar thought experiments will front run the assured demand from new funds.

There are many reasons to be bearish on the short term price of Bitcoin and Ether. Hard forks, scaling issues, and proof of work changes are respectable reasons to doubt the veracity of this bull market. But these fund managers must shit or get off the pot. A stable and strong bid from hedgies will embolden bullish speculators to BTFD, and shorts to cover quickly.

First DCO, Then ETF

Congratulations to Paul and Juthica at LedgerX for reaching the promised land!

There are 16 registered Derivatives Clearing Organisations (DCO) in America. This week the CFTC approved LedgerX’s application to become the 17th active DCO. LedgerX specifically focuses on Bitcoin related derivatives. This is a monumental shift in attitude of US regulators towards Bitcoin and the digital currency industry as a whole.

The CFTC deems LedgerX capable of safely storing significant amounts of Bitcoin on behalf of exchange members. One of the biggest concerns that any regulator has is how a regulated entity will handle Bitcoin storage. The various exchange hacks over the years proves that Bitcoin custody is a dangerous endeavour. Should this happen, the loss of face will surely end the career of the bureaucrat in charge.

Only large trading accounts can become authorised participants on LedgerX. To trade on LedgerX, participants must have several millions of dollars in cash. That restricts the universe of traders to large financial institutions. The popularity of the exchange come launch will provide clues as to the appetite of banks and large trading houses towards Bitcoin.

The regulatory stamp of approval does not mean LedgerX won’t get hacked; it provides convenient cover in case they do. If a financial institution trades on LedgerX and Bitcoins are lost, they can wash their hands of the loss because they traded with a regulated institution.

CFTC raises one Bitcoin DCO, action to the SEC

If the CFTC is looking towards the future of finance, what conversations are big dogs at the SEC having? Can they sit back and continue to deny applications for ETFs? They can’t claim Bitcoin is unsafe, for their sister regulator body has deemed them so. They can’t claim that Bitcoin provenance presents an issue for a retail traded product, for a regulated DCO holds Bitcoin.

It is naive to assume the CFTC and SEC heads do not break bread. Traditional equity, fixed income, and commodity listed products’ trading volumes are declining. Banks’ quarterly earnings reports point to a secular decline in equity, fixed income, and commodity trading volumes. As I have repeatedly said, Bitcoin and digital currency trading represents the fastest growing fee pool globally.

The regulatory bodies are slaves of the TBTF financial institutions. One way or another they will earn fees from digital currency trading. The disdain previously shown by bank chieftains is purely for public consumption.

2017 proves without a doubt that facilitating trading and providing financial services for digital currencies is a viable long term business. Hundreds of millions of dollars in fees earned on an industry with a sub-$100B market cap is truly astounding. The demand for a subset of non-correlated assets will force banks to play ball.

Mere retail mortals cannot trade on LedgerX. However, we should be excited for the messiah, an ETF. The SEC cannot continue to be a prude rose. I predict that one or more applications for an ETF will be approved within the next 18 months.