Crypto Trader Digest – Jan 18

Bitcoin Hearnia


The New York Times article about Mike Hearn’s ragequit from Bitcoin tanked the price 20% in 24 hours. Hearn called Bitcoin a failed project due to the failure of the community to adopt his BitcoinXT solution to the block size debate. He then threw all his toys, said he’s done with Bitcoin, and “sold” his stash. Slowly then quickly the price dumped to a low of $350.

Did Hearn reveal any new flaws in Bitcoin? No. The difference is that the New York Time wrote about it, and he was a core developer. When the New York Times writes something negative about Bitcoin emanating from a long time Bitcoiner you have to take notice. But after the knee-jerk reaction to go short 100x, you must evaluate whether any new information has entered the market.

Without a larger block size, Bitcoin could be relegated to a settlement currency that’s too expensive for small transactions. Hearn argues that this is a bad thing. Bitcoin is used primarily as collateral that can be accessed by anyone with an internet connection. Bitcoin is digital gold. We don’t carry around 1oz gold coins, nor do most people send around 1 Satoshi. If Bitcoin ultimately is only used for larger transactions, that doesn’t diminish its central role as a global form of collateral.

The Chinese own the majority of the hashing power. Nothing new here. Chinese internet sucks. Yeah, I’ve been there and agree, but I haven’t heard any Chinese miners cite that as a concern. Also, nothing new here.

Hearn attempted to craft a solution to the block size issue. Unfortunately it wasn’t gaining traction as quickly as he would liked so he declared Bitcoin dead. Bitcoin’s strength is the consensus mechanism by which changes must be made. If you are bearish Bitcoin because one or two men couldn’t immediately change the course of the project on their timetable, you have missed the entire point of Bitcoin. If Hearn thought trying to steer the course of Bitcoin was tough, I can’t wait to see how he handles dealing with large financial institutions at R3. R3 is an organisation that is bringing together large financial institutions to craft blockchain solutions. I look forward to a followup article in 2 years when he ragequits R3.

Will Hearn quit Bitcoin forever? I highly doubt it. Hearn wants the block size to be increased. How better to galvanise the community to adopt a solution than hitting everyone where it hurts. If a New York Times article drops miners’ revenue and retained earnings by 20% in 24 hours, they will make finding a solution a priority.

What should traders do? Bitcoin is ruled by sentiment. This article is still propagating. Even though the price rebounded sharply from $350 to $380, this is not over yet until… Until the PBOC resumes devaluing the CNY. A break below $350 will lead to a retest of $300. While I believe China’s CNY devaluation is the most important bullish factor in 2016, nothing moves in a straight line.

Capital preservation is rule #1. Outright positioning longer than a few hours will be tough until the PBOC shows its hand again. Spread trades are like those mentioned in the previous section are more prudent. The Bitcoin frown will not be turned upside down while this story is making the rounds.

A Bitcoin Believer’s Crisis of Faith

How To Trade Chinese New Year

year of monkey

China has a tough road ahead in 2016. Faced with collapsing world trade and a banking system bloated with bad loans, they have no choice but to export deflation abroad. That means lowering domestic interest rates, and weakening their currency.

The problem for China is that everyone knows the CNY is heading lower. Rich and poor comrades are rushing to front run the PBOC. The widening of the CNY vs. CNH spread was the perfect example. The PBOC is closing all obvious channels by which Chinese capital can escape. They need every Kuai to help rectify their gigantic credit bubble.

Looking through monetary history, central banks and governments like to unveil massive monetary policy changes during the weekend or bank holidays. The PBOC is quite lucky; the Chinese New Year holiday presents an excellent opportunity to massively devalue the Yuan and cut interest rates without the threat of capital flight. The Chinese banking system and capital markets will be closed from February 7-13. During Chinese new year, all things financial come to a halt. The PBOC has free reign to duck hunt dormant capital with impunity.

The PBOC will schlong (I hope The Donald retweets this) the CNY by devaluing it 5%-10%. That is my prediction. The next question is: if you share my view, what trades are appropriate?

The no brainer trade from August 2015 until last week was to short USDCNH. CNH is the offshore and unrestricted flavor of the RMB. The CNY is the onshore and restricted version. The PBOC is determined to stamp out large short sellers of CNH. They began heavily intervening in the spot market causing overnight CNH interest rates to spike. Shorts must pay overnight to borrow CNH. Today the PBOC imposed reserve ratio requirements on Mainland banks who hold CNH offshore. This further restricts supply, as banks cannot lend freely to willing speculators.

Institutional investors have access to CNH NDFs (non-deliverable forwards) and CNH currency options. The majority of readers cannot trade these products. Don’t be sad, that’s why there is Bitcoin. Below are my top Chinese New Year trades.

Long XBTCNY vs. Short XBTUSD Spot

For those who can deposit CNY onto a Chinese exchange, sell CNY vs. buy Bitcoin onshore in China. Then sell Bitcoin vs. buy USD on your prefered margin trading platform. You need to use a margin trading platform where you can borrow Bitcoin with which to short. The Bitcoin risk cancels out, and long USD vs. short CNY remains.

Due to the banking holiday, the CNY must be in China before February 7th. Also you will not be able to add additional size to the position until after Chinese New Year.

Long Weekly BitVC CNY Futures vs. Short Weekly BitMEX XBT7D Futures

The BitVC futures settle based on the CNY price of Bitcoin on the major Chinese exchanges. The BitMEX weekly futures settle on the TradeBlock XBX Index, which represents the major USD Bitcoin exchanges. Again the Bitcoin risk cancels out, and traders are left long USD vs. short CNY. The advantage of this strategy is that margin can be posted solely in Bitcoin. You can upsize the trade during the bank holiday period if it is going in your favor.

Long BitMEX March XBTH16 Futures vs. Short BitMEX Weekly XBT7D Futures

This is a volatility and interest rate play. If the devaluation occurs, Bitcoin will rally sharply. Forward expectations for price and volatility of Bitcoin will increase. Because the March future has more time value than the weekly future, it will appreciate more.

If the expectation is for CNY to devalue and Bitcoin to rally, why not just go long Bitcoin? There are no guarantees in life. Using spread trade strategies limits risk, but also the upside. If the devaluation doesn’t come to pass, the losses will be much less than an outright long position.

Yuan Borrowing Rate Surges in Hong Kong: What You Need to Know

China Said to Put Reserve Rule on Offshore Bank Yuan Funds

BitMEX Arbitrage Webinar Lesson 3

Thank you to everyone who tuned into Lesson 2 last Wednesday. Lesson 3 will air this Thursday 21 January 03:00 GMT.

Lesson 3 Topics:

  • Constructing Futures Term Structure
  • Curve Steepeners
  • Curve Flatteners

Lesson 3 Live Broadcast Link

Lesson 2 Recording

Lesson 3’s slide deck and spreadsheets will be provided on our blog and via email prior to Thursday.


Crypto Trader Digest – Nov 30

Welcome To BlockMEX



Arthur: Hi Garry (VC), I want to tell you about a pivot we just made. BitMEX is now BlockMEX, we allow trading of Blockchain Derivatives.

VC: Oh that’s great. You know we are not that interested in Bitcoin, but very positive about the Blockchain. Please tell me more.

Arthur: Clients use Blockshares to trade on BlockMEX. And we allow the trading of financial derivatives using the Blockchain.

VC: Wow that’s awesome. So you no longer use Bitcoin? You were previously called BitMEX right?

Arthur: We never were a Bitcoin company. The “Bit” merely stood for digital information, you know like Bits and Bytes.

VC: Gotcha. So what kind of Blockchain do you use for your derivatives, do you touch Bitcoin in any way?

Arthur: Touch Bitcoin, oh heavens no. We created our own Blockchain that uses Blockshares. It is proprietary to BlockMEX.

VC: Wow, you created your own Blockchain? I’m really impressed. So if anyone can trade anything using the BlockMEX Blockchain, how do regulations work?

Arthur: Regulations are irrelevant with the Blockchain. It’s all decentralised, so no legacy regulations apply to BlockMEX.

VC: Man, the Blockchain is so amazing. So what about trading volumes?

Arthur: We have not done a single trade on BlockMEX yet. That’s okay, we’re just pre-revenue. Our technology is meant for large financial institutions. We are going to revolutionise how they trade derivatives.

VC: I totally agree that legacy finance needs services like yours. What about your team? Finding good Blockchain engineers is getting harder and harder.

Arthur: Our team is top notch. We have expert MySQL and PHP developers straight from Tokyo. They have been involved with the Blockchain since 2010.

VC: I really think you guys are onto something. How can our firm, FOMO Capital, get involved?

Arthur: On the back of our strong traction, we are raising $116 million at a $500 million valuation.

VC: That sounds very reasonable. FOMO Capital typically writes checks for $50 to $100 million. We are interested in leading your round.

Chinese Exchanges: Bitcoin Shadow Banks


How do Chinese Bitcoin exchanges make money when they charge no fees to trade spot? When asked, management of the big three (OKCoin, Huobi, and BTCC) assure us that they do indeed make money. In this post, I will conduct a thought experiment as to how I would monetise a spot business that charges zero fees in China. I have no concrete evidence to back up any of my claims other than deductive logic.

China accounts for the vast majority of all on-exchange Bitcoin trading. Exchanges must therefore have a large balance of customer CNY and Bitcoin. I believe that Chinese exchanges act as shadow banks. They borrow at 0% from clients who wish to trade Bitcoin, and lend out customer funds by purchasing China debt instruments.

When the product is free, you are the product. Chinese Bitcoin exchanges use the captive CNY held to trade Bitcoin to earn interest income. How much does it cost to operate the exchange? I have no hard data, but the big three generally have around 150 staff. Assume an average salary of 10,000 CNY per month. Demand deposits yield between 3% to 5%; this is the least risky form of lending as it can be redeemed at any moment from the bank to satisfy withdrawals. The yearly salary costs alone are CNY 18 million. To earn that amount in interest income at 5% requires CNY 360 million or $56 million of stable customer funds. Given the reported trading volumes, it is reasonable to assume that the big three could each possibly hold this amount of capital.

Unfortunately only investing using demand deposits just barely covers salaries. If the exchange is to turn a profit, they must step out on the risk and maturity curve. Private companies cannot obtain credit from banks. All bank credit is reserved for State Owned Enterprises (SOE). In the last decade, high interest rate Wealth Management Products (WMP) have emerged to provide credit to SMEs. The banks underwrite these WMPs off balance sheet which are secured on a company’s assets. WMP yields range from 10% to 20% and have various maturities. Investors believe there is an implicit guarantee provided by the issuing bank. The belief is the government would not let WMPs fail because of the catastrophic losses retail investors would suffer. Therefore, in the few cases where it appeared a company would default on a WMP product, the banks have stepped up and rolled the debt.

Like any bank, a Chinese exchange must keep a portion of the float liquid so they can’t lend the entire balance out via WMPs. The below table assumes that the Demand Deposit rate is 5% and the WMP rate is 20% per annum. NIM is the Net Interest Margin, which in this case is the full interest rate since customers are paid nothing on CNY they hold with the exchange.

% Liquid % WMP Yearly NIM Costs Profit
50% 50% $7,031,250 $2,812,500 $4,218,750
40% 60% $7,875,000 $2,812,500 $5,062,500
30% 70% $8,718,750 $2,812,500 $5,906,250
20% 80% $9,562,500 $2,812,500 $6,750,000
10% 90% $10,406,250 $2,812,500 $7,593,750

As the table shows, the more credit and maturity risk management is willing to take the more money they make. Given there is no regulation as to how the exchange holds customer funds, management can invest in whatever they like to generate a positive NIM. It is not a far stretch to imagine the CEO’s punting the A share market in their spare to time to generate enhanced returns.

Bitcoin trading has become a side show, and these entrepreneurs have created very profitable banking institutions. Because they have excess cash, they are able to pledge customer CNY to fund whatever assets will generate a positive risk adjusted NIM. The Chinese Bitcoin exchange model will be copied in other emerging markets with broken credit intermediation and high nominal rates of interest. If I was opening a spot Bitcoin exchange in India, this is the model I would choose. Private credit in India is hard to come by, and nominal rates are sky high.

The Magic Number Is 6.40

image (3)

The IMF is set to announce the CNY’s inclusion into the SDR basket today. Analysts expect that after the inclusion, the PBOC will intervene less in the FX markets and allow the CNY to depreciate further. 6.4 is the highest level USDCNY reached this summer after the shock devaluation.

If USDCNY rises above 6.4, the dominoes may begin to fall. The expectation of future weakness will become more acute. Ordinary citizens will search for any means to preserve their purchasing power. The Bitcoin meme is gaining ground in the financial media. Zerohedge mentions Bitcoin daily when talking about the Chinese financial markets. Once the mainstream pundits at Bloomberg, FT, and WSJ discover Bitcoin, make sure you have your moon boots ready.

Apart from the Federal Reserve meeting December 16th, nothing else will have more impact on Bitcoin than the USDCNY exchange rate. The above chart shows the Bitcoin premium expansion as CNY has depreciated (as USDCNY rises, CNY is worth less USD). To check the PBOC’s daily USDCNY interbank rate click here. If you are lucky enough to have access to Bloomberg or Reuters, search for the USDCNY daily fix. It is announced each day at 9:15am Beijing Time GMT + 8.

Don’t fight the Fed. In Bitcoin, don’t fight the PBOC.

XBT Spot


Screen Shot 2015-11-30 at 1.36.28 pm

$400, here we come. Global macro is providing so many positive catalysts for Bitcoin it is hard to keep them all straight. Argentina has descended into currency chaos. The CNY depreciation continues. The Fed is expected to lift rates and torpedo asset markets globally.

Yet – $400 won’t be taken as easily as it was one month ago. The retrace from the graces of $500 has been slow and steady. However, the recent price action contains the wiff of FOMO, and the upward pressure is likely to accelerate if the CNY devaluation continues.

Trade Recommendation:

Daily 100x Futures, XBT24H: Buy XBT24H while spot is $375 to $380 with an upside target price of $385.

Weekly 50x Futures, XBT7D: Buy XBT7D while spot is $375 to $385 with an upside target price of $400.