Crypto Trader Digest – May 16

Keep Your Wallets on Ice

This weekend, Gatecoin was hacked. It appears losses may be as much as US$2M. The CEO, Aurelien Menant, is a friend of mine and a great entrepreneur. I am certain they are doing everything possible to recover the funds and get the exchange back online again quickly.

The security of user funds is our #1 priority. In light of this hack, I want to reiterate the security policies of BitMEX:

No Hot Wallet

The most common attack vector for Bitcoin exchanges is via their hot wallets. A hot wallet is a digital currency wallet where an internet exposed server has access to the private keys. A hot wallet allows users to withdraw their Bitcoin at any time without human intervention from the exchange.

BitMEX stores all customer funds using multi-signature wallets. No private keys are held on any internet exposed computer. 2 of 3 partners must manually sign each withdrawal from BitMEX. If someone hacked, they would not be able to steal any customer funds.

Many exchanges do hot/cold hybrid stores, where there are withdrawal limits per-user and per-day on the hot, and it must be manually filled via the colds. This can be a good strategy, but it significantly increases complexity – the enemy of security. It appears Gatecoin had a hybrid approach, but the hackers were able to redirect deposits to the hot wallet.

Withdrawals Once Daily

Because all withdrawals must be processed manually by 2 of 3 partners, withdrawals are only processed once daily at 13:00 UTC. This allows us to manually review each withdrawal. In some cases where the user behavior is out of the ordinary, we personally contact a user to re-confirm their withdrawal.

Real-Time Auditing

BitMEX monitors the internal record and the blockchain balance of every account. We use many disparate blockchain datasources. If a conflict occurs, trading is suspended and the partners are notified.

BitMEX’s trading engine sums all accounts to zero at every tick. This would normally be a very time-consuming process, but the superior financial technology used at BitMEX allows us to quickly validate every single execution as a part of the system as a whole. Even a satoshi’s rounding error will cause trading to halt.

We take security very seriously. The policies above are among the most stringent at any exchange. In fact, BitMEX was the first exchange to run 100% multisignature wallets and 100% offline wallets. Despite some pressure for faster withdrawals, we have not compromised. We have found that users enjoy the peace of mind, despite the slight inconvenience.

Fixed vs. Floating Interest Rates

With the introduction of the XBTUSD swap, it is time for a primer on fixed vs. floating interest rates. A futures contract and a swap are the same instrument. The only difference is how the underlying asset is financed.

The reason traders use futures and swaps is that they wish to obtain an asset’s price performance without physically owning that asset. At the end of the daisy chain, someone must purchase the underlying asset with cash to provide the performance.

Cash has a cost. Instead of buying Bitcoin, you could lend your USD and earn a rate of return. The financing leg of a future or swap compensates for the opportunity cost of cash.

A futures contract has a fixed maturity. If I sell a futures contract for one month, my USD is tied up for the same amount of time. As a seller I need to earn a fixed rate of return to compensate for my USD. It is a fixed rate of return because the maturity date is fixed. It’s like a bond. If you borrow $95, but must pay back $100 in one year, you effectively pay a 5% fixed rate.

BitMEX swap contracts do not have a maturity date. Therefore if I sell a swap, my USD is tied up for an undetermined amount of time. As a seller, I need to earn a variable rate of return while I hold the swap to compensate me. It’s like a variable rate mortgage. The bank will lend you a sum of money, but the interest you pay each month changes.

Same Same But Different

Holders of the XBTUSD swap pay or receive interest on a daily basis. The amount they pay is based on that day’s funding rate, and the value of the position using that day’s spot price.

Imagine you hold the XBTUSD swap for two days. Essentially the XBTUSD swap can be decomposed into two daily expiring XBTUSD futures contracts. The interest rate is fixed on a daily basis, that is why a swap held for two days is the same as two daily expiring futures contracts.

Interest Rate Arbitrage

Assume the trading universe is comprised of Bitcoin spot, Bitcoin 1 day future (1D), Bitcoin 2 day future (2D), and a XBTUSD swap that is held for 2 days. What is the daily interest rate that the XBTUSD swap must pay on day 1 and 2 in a no arbitrage situation?

Spot = $100
1D Price = $110
2D Price = $127

Day 0 to 1 Interest Rate

$110 / $100 - 1 = 10%

Day 1 to 2 Interest Rate

$127 / $110 - 1 = 15%

The swap must pay 10% on day 1, and 15% on day 2 based on the prices of the one and two day futures contracts.

Assume you buy the swap. The funding rate for the first day is known when you purchase the swap. However, the next day’s rate is unknown. If the swap rate is higher than 15%, you are better off holding futures contracts. If the swap rate is below 15%, you are better off holding swaps.

If you believe that interest rates will rise in the future, you should buy futures (pay fixed) vs. sell swaps (receive floating). If you believe that interest rates will decline in the future, you should sell futures (receive fixed) vs. buy swaps (receive floating).

This fixed vs. floating interest rate arbitrage can be accomplished by using BitMEX Bitcoin swaps and competing platform’s futures contracts. I will delve deeper into interest rate arbitrage trades in future newsletters.

Synthetic USD

I have spoken at length about NIRP (negative interest rate policy), and its effects on Bitcoin and the digital currency industry. The heart of my argument is that using Bitcoin, people can store their cash electronically and insulate themselves from the institutionalised theft being visited upon savers globally.

The one problem with Bitcoin from a saver’s perspective is the price volatility. Given USD is the world’s reserve currency, savers desire an electronic synthetic USD. With the launch of XBTUSD, BitMEX can finally create such a product.

What Is A Synthetic USD Dollar?

I will refer to the BitMEX Synthetic USD as BUSD. Just like regular USD, BUSD is backed by a pool of assets. The USD is backed by US Treasury bonds. BUSD is backed by Bitcoin plus a short XBTUSD swap position.

Each XBTUSD swap is worth $1 of Bitcoin. A portfolio of long Bitcoin and short XBTUSD is equivalent to holding synthetic USD. To understand the mechanics behind this, please read In Depth: Creating Synthetic USD.

Assume the spot price is $500. To create 500 BUSD, you buy 1 Bitcoin and sell 500 XBTUSD swaps.

BUSD For Speculation

BitMEX’s mission is to use digital currencies to allow investors to trade any type of financial asset. The majority of tradable assets globally are priced in USD. Using BUSD as the margin currency allows traders to speculate on USD denominated assets using Bitcoin, but their collateral is not exposed to price risk.

Imagine trading an Oil futures contract on BitMEX where margin, profit, and loss are denominated in BUSD. This is the future of BitMEX. Using the synthetic fiat structure, BitMEX can create synthetic version of major fiat currencies and allow speculation on many more asset class while stripping out the Bitcoin price risk.

DAO Explosion

“The DAO”‘s Initial Coin Offering (ICO) has raised over US$100 million in under one month. More than 12.5% of ETH’s total supply has been tendered for DAO tokens. Just hours ago, The DAO’s fundraising (US$118M) surpassed Star Citizen (US$113M) to become the successful crowdfunding campaign ever. Read on to find out what is actually happening, and how you can trade it.

What is a DAO?

DAO stands for “Decentralized Autonomous Organization”. The particular DAO we’re talking about is creatively named “The DAO” (really) and information is hosted at DAOHub. “The DAO” itself is a decentralised VC firm. The limited partners are holders of DAO tokens. Proposals are submitted to DAO holders who vote on whether to disburse funds in the form of ETH to the project managers.

To capitalise the DAO fund, an Initial Coin Offering (ICO) for tokens is currently being held. Each DAO Token is backed by 0.01 ETH. The ETH raised will be used to back various projects by holding votes. The more tokens you hold, the more votes you have.

Projects submit public proposals requesting funding. One prominent example of a public proposal is makes IoT-enabled locks that accept payment based on the Ethereum blockchain.

How Does the ICO Work?

100 DAO tokens are created by sending 1 ETH to the DAO organisation. Anyone who sends ETH to the correct address in the correct amount will receive DAO tokens.

The price of DAO per ETH increases throughout the ICO, to a maximum of 0.015 ETH per DAO. After 28 May 2016, the DAO ICO closes, and DAO can only be purchased on the secondary market.

How to Value DAO

1 DAO == 0.01 ETH regardless of what you paid during the ICO. That means if you buy 1 DAO for 0.015 ETH, it is still only worth 0.01 ETH intrinsically. 

DAO has intrinsic value in ETH terms because DAO holders can burn their DAO and receive ETH back. However, they will only receive 0.01 ETH per token. There are a few caveats:

  • Once proposals are backed, the amount of ETH that is received by burning DAO declines.
    • The first ETH used is that raised after the 1/100 period. This is called extraBalance. While it is still available, the burn rate remains at 1/100.
  • Burning DAO takes about 7 weeks and is not trivial. It cannot be started until May 28. The process:
    • Create a proposal to split the DAO with yourself named as curator (1 week waiting period)
    • Call `splitDAO()` to create a new DAO owned by yourself (at this point your unallocated tokens get transferred)
    • Wait 28 days for new DAO to finish creation
    • Create a proposal to send yourself your ether and wait for it to close (2 weeks)
    • Execute your proposal in your new DAO

Trader Psychology

The greed is palpable. Traders are rushing to convert their ETH into what they believe will be the next hottest altcoin. Equity IPO investors exhibit similar behavior. Banks dole out allocations to their favoured clients so that they can flip the underpriced IPO for a quick gain in the secondary market.

The main difference between equity IPOs and ICOs is scarcity. A company offers a finite amount of equity to the market. A hot IPO has many times more capital willing to buy than can actually do so. That is what leads to the secondary market pop after listing.

With ICOs there is no scarcity. Anyone who transfers ETH in the correct ratio will receive DAO. ICOs in the past tend to rise after they list. However, the absolute size of previous ICO’s was small. Apart from ETH, ICOs struggle to raise more than $5 million. DAO has captured more than 20x that. The ICO is so large, that trading volumes across the altcoin spectrum have collapsed. The ETH borrow rate has also skyrocketed as supply is soaked up in the DAO ICO.

The above is an hourly chart of the Poloniex ETH daily borrow rate. 0.01 is 1%.

The problem for DAO speculators is that there is too much of a good thing. If all the would be buyers have already subscribed during the ICO, who will be left on the margin to buy once it lists?

If the price doesn’t pop immediately after it lists, then everyone will be running for the exit. If DAO/ETH trades above 0.01 ETH, traders will sell on the secondary market. If DAO/ETH trades below 0.01 ETH, they will redeem DAO for ETH.

The characteristics of DAO mean that the market immediately after listing will not trade much above the floor of 0.01 ETH.

Over the next 3-6 months as projects receive DAO funding, the possible dividends from these projects will be the catalyst for an increase in price. That is, if they turn a profit, and if they decide to honestly redistribute it back to the DAO. This is a big if. However, the majority of traders participating in the DAO ICO will be long gone by that time.

The BitMEX DAOETH Contract

The ICO market is just getting started. Copycat projects will flood the market after the success of DAO. BitMEX createdDAOETH to allow traders holding Bitcoin to speculate on the price of DAO before and after it lists on the secondary market.

Each DAOETH contract is multiplied by 1 Bitcoin to arrive at a Bitcoin value for the contract (in finance terms it is quanto’d into Bitcoin). If DAOETH trades at 0.01 ETH, each contract is worth 0.01 Bitcoin. Margin, profit, and loss are all conducted in Bitcoin. The best part is that is the contract offers 3.33x leverage.

DAOETH expires on 24 June 2016, one month after the ICO concludes on 28 May 2016. The settlement price will be taken from Poloniex.

After 24 June 2016, we will list a DAOXBT swap similar to our ETHXBT swap. Given how successful the DAO ICO is, DAO may become a liquid altcoin in short order.


The upper-triangle I spoke of last week has been tested again this past week and we have seen the lower edge acting as a strong support with a few hits at the 445 level. We are now dithering around the 3000 CNY stronghold ($460sh). Only looking at the Bitcoin charts, this key psychological level should be broken after this coming week as the lower edge crosses over it; and then it will be another 2 weeks beyond that where this triangle finally closes around $467 where we should extend upwards.

However, we have some other factors in play right now. The price movements between ETH and XBT exhibit a strong inverse correlation, as traders switch in and out of each coin to take advantage of current market anomalies. The first of which is the image floating around that shows a trader’s ETH Balance on OKCoin, suggesting OKCoin is about to list it as a trading product (ETH instantly jumped 10% once this was posted to reddit).

Secondly, as stated above, with 12.5% of ETH’s total supply being locked away in DAO projects, the supply is dwindling with current borrowing rates spiking to over 50bps per day on Poloniex. This is quite bullish for ETH (up until traders burn their DAO back into ETH), as a trader now can buy ETH, lock in 0.5% a day in funding and hedge the underling. As a result of the negative correlation, I don’t believe we will have some positive upside action on XBT for the next week.

Trade Recommendation: If you haven’t learnt this lesson yet, then there is no time better than the present: Buy the rumor sell the fact. With OkCoin not officially announcing the listing of ETH yet, this is a good opportunity to buy ETH. By entering into a long ETHXBT swap on BitMEX you can take advantage of the upside and earn the current funding levels. Just be on the lookout for that official OKCoin announcement!

Risk Disclaimer

BitMEX is not a licensed financial advisor. The information presented in this newsletter is an opinion, and is not purported to be fact. Bitcoin is a volatile instrument and can move quickly in any direction. BitMEX is not responsible for any trading loss incurred by following this advice.