In Depth: Creating Synthetic USD

In the June 22nd Crypto Trader Digest, I outlined how it is possible with Bitcoin and BitMEX futures contracts to create synthetic USD that can be held outside governmental and banking control. The goal is to give people all the benefits of physical cash without having to carry it on their person. The rise in confiscation by police and limits on cash transactions are herding citizen’s wealth into conduits which are at the complete control of national governments. This post will explain in detail how to create, store, and spend synthetic USD. It will also touch on margin considerations which are important to understand when using financial derivatives.

Assume you have $1,000 in cash and you want to create synthetic USD using Bitcoin and BitMEX futures contracts. The price of Bitcoin is $100.

  1. Exchange $1,000 for 10 Bitcoin on a spot exchange.
  2. Deposit 30% of your Bitcoin on BitMEX as initial margin, secure the remaining 70% using a wallet or storage method of your choice.
  3. Sell BitMEX futures contracts to lock in the USD value of Bitcoin. BitMEX XBU hedging contracts are each worth $100 of Bitcoin; therefore, you sell 10 contracts.
  4. Every time you wish to spend some of your synthetic USD (i.e. sell Bitcoin), buy back the equivalent USD amount of futures contracts to keep a hedged position.

Step 1:

All BitMEX futures contracts settle on the Bitfinex Bitcoin / USD price. When purchasing your Bitcoin, attempt to match the Bitfinex price.

Step 2:

BitMEX offers leverage to traders on the exchange. For our hedging futures contracts the have the prefix XBU, we require traders to have 30% of the position’s Bitcoin notional as margin. Your Account Equity / Position Value is not allowed to drop below 20% (this is the maintenance margin), if it does liquidation of your position will begin. Email notifications are sent alerting you if your account balance is getting low.

Step 3:

Each BitMEX XBU futures contract is worth $100 of Bitcoin.

Bitcoin Value = $100/Price * Number of Contracts

To determine the number of futures contracts that you must hedge, calculate the USD value of your Bitcoin and then divide by $100. For this example you have $1,000 worth of Bitcoin, you must sell 10 contracts.

Step 4:

After you created 1,000 USD synthetically, you wish to spend $100 on an item. You first calculate the Bitcoin amount to sell, assume the spot price is $200 so you sell 0.5 Bitcoin. Then calculate how many futures contracts that represents:

USD Value / $100 = $100/$100 = 1 Contract

You buy back 1 futures contract so that you now have $900 of synthetic USD. If you plan to frequently spend the USD, then sell a monthly futures contract. These contracts will be the most liquid and will have the least slippage when entering and exiting. If you plan to not spend the USD, use a longer dated maturity or bi-quarterly contract. This reduces the frequency of re-establishing your short futures position. With a monthly contract at the end of each month when the contract expires, you must sell the next month contract to keep a perfect hedge.

Margin Considerations

The purpose of creating synthetic USD is to have as much personal control over your wealth as possible. Therefore, it makes sense to use the leverage provided by BitMEX. The initial margin is 30%, and the profit and loss of BitMEX futures contracts is in Bitcoin.

The price of Bitcoin and the BitMEX futures contract will change over time. If the price rises, your BitMEX futures contracts will show a loss. If the loss is big enough, additional margin must be deposited on BitMEX or your positions will be liquidated. The below chart is meant to illustrate that even if the price rises and you deposit additional Bitcoin with BitMEX, the USD value of your Bitcoin + BitMEX futures contracts remains constant.

Bitcoin / USD Secured Bitcoin Initial Margin Bitcoin PNL Position Value Equity / Value Margin Call? Additional Funds Margin Secured Bitcoin Total Bitcoin Holdings USD Value
$80 7.00 XBT 3.00 XBT 2.50 XBT -12.50 XBT 44.00% No 0.00 XBT 5.50 XBT 7.00 XBT 12.50 XBT $1,000
$90 7.00 XBT 3.00 XBT 1.11 XBT -11.11 XBT 37.00% No 0.00 XBT 4.11 XBT 7.00 XBT 11.11 XBT $1,000
$100 7.00 XBT 3.00 XBT 0.00 XBT -10.00 XBT 30.00% No 0.00 XBT 3.00 XBT 7.00 XBT 10.00 XBT $1,000
$110 7.00 XBT 3.00 XBT -0.91 XBT -9.09 XBT 23.00% No 0.00 XBT 2.09 XBT 7.00 XBT 9.09 XBT $1,000
$120 7.00 XBT 3.00 XBT -1.67 XBT -8.33 XBT 16.00% Yes 1.17 XBT 2.50 XBT 5.83 XBT 8.33 XBT $1,000

You start out with 10 Bitcoin valued at $1,000. You sold 10 BitMEX XBU futures contracts for which you deposited 3 XBT as initial margin. The other 7 XBT you kept under your control. As the Bitcoin / USD price fluctuates, the futures contracts will show a profit or a loss (PNL). If the contracts lose so much such that the Equity / Value goes below 20% (the minimum margin requirement), you must deposit additional Bitcoin to bring the ratio back to 30%. If the price reaches $120, BitMEX would require you to deposit an additional 1.17 XBT. The Total Bitcoin Holdings column represents your personally secured Bitcoin, and the margin and net profit deposited with BitMEX. As you can see, regardless of the Bitcoin / USD price and even if you needed to top up your BitMEX margin account, you will still have 1,000 synthetic USD.