Crypto Trader Digest – Dec 8

8 December 2015 Casper Cheng

How Will You Spend Your Helicopter Money?

Finnish lawmakers are ready for the nuclear option. A bill under consideration will hand out $900 to every citizen each month. In their desperate attempt to kick start economic activity, Finland will be the first developed nation to drop money from helicopters.

The theory is that each citizen will go out and spend their newfound wealth on goods which will spur inflation and economic activity. The poorer members of society will use this money on necessities, food and shelter. The economy will not magically produce more of these goods. Prices will rise and these members of society will be no better fed or housed than before. Only now they will clamor for additional free money to make up for the loss of purchasing power.

The wealthier members of society will watch the value of their savings decline. They will be searching for assets that can preserve their wealth. Real estate, gold, art, jewelry these are the conventional means of wealth preservation. Once these assets reach ridiculous prices, unconventional assets become attractive. Bitcoin tops my list as an asset that will gain favor amongst the wealthier members of society.

Lawmakers globally will watch and learn from Finland’s experiment with helicopter money. Citizens around the globe will demand that instead of handing free money to banksters, government’s hand cash directly to those most in need. Start hoarding now because as the helicopter money movement spreads, prices of conventional and unconventional means of wealth preservation will skyrocket.

It Begins: Desperate Finland Set To Unleash Helicopter Money Drop To All Citizens

The China Bitcoin Premium Is On The Rise

The most important indicator for Bitcoin is flashing green once again. Over the past two weeks, as the CNY weakened, the China Bitcoin premium rose. The premium is now approaching 5% as USDCNY flirts with 6.40. All hell will break lose if the Fed raises rates as expected. EM currencies globally have been getting the stick all year as the dollar surged higher. EM countries will descend further down the mercantilist path as they try to defend what market share they have left of world trade.

China will not sit idly by and watch their competitiveness erode vs. Europe, Japan, and South Korea. Unlike most safe haven assets such as Gold that are priced in dollars, Bitcoin is priced in CNY. The PBOC will gradually allow the market forces to take the CNY lower. Up until now, they have gently guided the CNY lower by intervening in the spot markets on a daily basis to stem the selling pressure.

Apart from China, citizens of other emerging markets whose currencies are rapidly depreciating will be scrambling to purchase assets to preserve what wealth they still retain. Argentina and Brazil are two markets where Bitcoin trading volumes will increase rapidly. Argentina’s central bank is out of USD and is set for yet another default. Brazil is experiencing a political crisis, an impeachment trial of the president is set to begin. Concurrently, Brazil’s economy is collapsing due to falling world trade and commodity prices.

For the reasons mentioned above, A Fed rate hike on December 16th is positive for Bitcoin. I still have doubts whether the Fed will follow through on their promise to normalise rates. The calls for a continuation of the 0% status quo are growing. Yellen might still get cold feet in the face of the growing dissent from the likes of the IMF, World Bank, and Bank of International Settlements. Pay close attention to any public comments from Fed governors. If they indeed back down from a rate hike, they will attempt to telegraph their intentions to the markets in the days ahead.

It’s Raining Coin

Goldman Sachs recently filed a patent for SETL coin. This crypto currency is meant to handle settlements of financial assets. Get ready for a slew of patent filings for various coins from major multinational banks. By now, most banks have an internal team working on various ways blockchain technology can help their business.

The banks certainly will not build tools and innovations on top of the Bitcoin protocol. Open source and decentralisation don’t jive with centralised rent seeking banks. They will each release their own coin aimed at performing similar functions. The battle of bank coins has begun.

Ultimately the regulators will choose the winner. After the GFC and the public outcry against the financial services industry, regulators will be loath to introduce radical changes to the financial system that might fail. As such, the various bank coins will be great PR exercises, but I highly doubt any real changes will be made any time soon.

Capturing The Liquidity Premium

POKEMON TX DATE : 29 MARCH © SKY ONE — POKEMON
TX DATE : 29 MARCH
© SKY ONE

The daily 100x Bitcoin future, XBT24H, is BitMEX’s most liquid product. The next most liquid product is the weekly 50x Bitcoin future, XBT7D. XBT24H exhibits a liquidity premium. The positive USD gamma associated with being long a quanto contract means that XBT24H usually trades at a higher annualised basis than XBT7D. Traders who wish to capture this liquidity premium while remaining price neutral should sell XBT24H and buy XBT7D.

Trade Mechanics:

XBT24H usually trades at the highest premium during the first 6 hours of trading. XBT7D re-lists each Friday at 12:00 GMT. From 12:00 GMT to 18:00 GMT buy XBT7D and sell XBT24H in equal quantities. Each day when XBT24H expires, re-sell the same number of XBT24H contracts plus an additional amount to hedge the profit made. Each day you will earn the premium of XBT24H over spot. XBT7D also trades at a premium, and each day you will lose money as XBT7D decays to the spot price.

The compounded return from selling XBT24H each day will be higher than the loss from XBT7D after 7 days. Using data from November 27th to December 4th, I calculated the net return from selling XBT24H each day over the first six hours, vs. the loss experienced by buying XBT7D on November 27th and holding until the December 4th expiry. The compounded return earned by selling XBT24H was 3.74%. The XBT7D loss was 1.74%, for a net return of 2%. Depending on the amount of leverage used, the return on equity will be much higher. Using 10x leverage on both legs equals a 10% return on equity per week. Annualised that’s 520% without taking any price risk.

Daily Return	XBT24H
Fri	0.86%
Sat	0.20%
Sun	1.08%
Mon	1.11%
Tue	-0.02%
Wed	0.35%
Thur	0.11%

For those who prefer not the trade directionally, this is a safer risk adjusted strategy that generates positive returns.

XBT Spot

$400 was breached momentarily this weekend. Bitcoin on the USD exchanges is now range bound between $390 and $400, and on the CNY exchanges Bitcoin trades slightly above $400.

The price will climb alongside the China premium. FOMO buying has not occurred yet. The slow and steady rally is healthy. Against a positive global macro backdrop, Bitcoin will continue climbing to the all important $500.

Trade Recommendations:

BitMEX 100x Daily Futures, XBT24H: Buy XBT24H while spot is $390 to $395, with an $405 upside target.

BitMEX 50x Daily Futures, XBT7D: Buy XBT7D while spot si $390 to $400, with an $410 upside target.

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.

Crypto Trader Digest – Nov 30

30 November 201523 September 2017 Arthur Hayes

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

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

$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.

Crypto Trader Digest – Nov 3

2 November 2015 Arthur Hayes

It’s China Stupid

As China goes, Bitcoin goes. This Halloween weekend, Bitoiners were either drinking in celebration, or fixated on their charts as China ripped and roared higher. XBTCNY reached a high of 2316 CNY or $364 this past Friday. I will devote the entirety of this week’s newsletter to questions surrounding China’s impact on Bitcoin.

Is China Using Bitcoin To Get USD?

The PBOC is attempting to halt the hot money fleeing China. Since the 4% devaluation in late August, the authorities began actually enforcing capital controls. Bitcoin is legal in China, and individuals can wire RMB to one of several large Bitcoin exchanges to exchange RMB for Bitcoin. Once they have Bitcoin, they are free to transfer it anywhere in the world to buy goods or services, or convert into another fiat currency.

Further devaluation is forthcoming for the RMB. The Chinese citizens know this, and are searching for ways to protect their wealth. One popular theory is that through Bitcoin, Chinese households will get access to USD. The Bitcoin corridor is very narrow, and even a slight uptick in this sort of activity would cause trading volumes and the price to skyrocket.

The above chart shows the ratio of XBTCNY volume on OKCoin.cn, Huobi, and BTCC vs. XBTUSD volume on Bitfinex, Bitstamp, Coinbase, itBit, and OKCoin.com. Each was indexed at 100 on October 1st. Each subsequent day’s index looked at the change in volume vs. October 1st. If Chinese households were using Bitcoin as a USD conduit, then XBTCNY and XBTUSD volumes would have the same magnitude of increase.

The chart clearly shows that there were actual inflows into Bitcoin that didn’t fully leak into USD. This is very price positive. There is actual organic demand from China for wealth preservation or pure upward price speculation using Bitcoin. As the rest of the world piggybacks on the surge in Chinese demand, that ratio will fall further.

USDCNY vs. USDCNH: The Bitcoin Angle

Currency trading in China is a complicated and fickle beast. There are three currency pairs to know about. The interbank USDCNY rate is set each morning at 9:15am by the PBOC. This is the rate at which member banks can trade USDCNY against the PBOC. USDCNY floats in a PBOC set band around the interbank USDCNY rate. USDCNY can only be traded onshore in China and is subject to capital controls. USDCNH is the offshore version of USDCNY. This pair floats in a band around the USDCNY rate. USDCNH cannot be imported onshore accept in a few circumstances that are irrelevant for this discussion.

USDCNY and USDCNH both have different forward curves, which represent the supply / demand dynamics of onshore and offshore CNY. Only domestic Chinese banks can participate in the deliverable USDCNY forward market, and this market is heavily regulated and monitored by the PBOC. Any bank globally can participate in the deliverable USDCNH forward market; the PBOC have very strong regulatory control over this market. Because of this, the USDCNH is a leading indicator of where the PBOC will set the interbank USDCNY, as banks can effectively use the offshore forward market to speculate. Recently USDCNH has traded at a higher price than USDCNY, which signals the market believes further CNY devaluation will occur.

The chart above shows the USDCNH premium (read: the market thinks CNY will be devalued) vs. the premium of Bitcoin in China. There is no clear correlation between the two metrics. The complicating factor is that the PBOC actively intervenes in the USDCNH forward market to narrow the differential. The PBOC does not want clear market signals of the impending devaluation. I still believe that a major motivating factor for China’s shift to Bitcoin is a real fear of currency devaluation.

How To Play The China Bitcoin Premium

The China Bitcoin Premium chart as the most important chart in Bitcoin. The premium rose substantially during the recent run up in price. The 5%-10% region is very important. If the premium breaks out of this range, it means the usual avenues of arbitrage are broken. Arbitrageurs provide a price dampening effect in China. If they are unable to effectively move money between China and Hong Kong, then Bitcoin and China will soar farther and faster than in November 2013.

The premium is close to the 10% level. Let’s examine how to properly arbitrage this premium.

Set up a Bitcoin account offshore (Bitstamp and Bitfinex are my top choices), and a Bitcoin account onshore (OKCoin.cn, Huobi, or BTCC are my top choices).
Set up a mainland Chinese bank account. If you live in Hong Kong, take the bus to Shenzhen and you can open a bank account with just your passport. The Chinese banking system is very easy to enter, but hell to exit.
Wire USD to your offshore exchange, then buy Bitcoin.
Send the Bitcoin to your onshore exchange, sell it to realise CNY, then withdraw the CNY to your onshore bank account.
Now comes the tricky part of converting CNY into USD or HKD. Every person is given a $50,000 equivalent FX limit each year in China. Assume that you have exhausted your limit. You can travel to China and withdraw 20,000 CNY and walk it across the border. If you want to do size, then you need a few friends to come with you each day. Or you can use a shadow bank to move the money from CNY to HKD. Unfortunately Beijing has begun cracking down on these bankers, and your money may or may not appear in Hong Kong.

With $10,000, you could make $800 per day in profit. However moving even $10,000 between China and Hong Kong on a daily basis is quite difficult. Therefore, I expect the premium to continue its upward ascent as the fear of continued CNY devaluation grows. Also remember that as the PBOC lowers the benchmark interest rates, it becomes less attractive to store savings with a bank, and more attractive to speculate on risky assets like Bitcoin.

Conclusion: Long And Strong

Unlike 2013, there are real concrete macro factors affecting the flow of CNY into Bitcoin. Bitcoin has passed through many trials and tribulations over the past two years. Many exchanges have fallen, but Bitcoin and the blockchain are still here. China and the rest of the world tackled the 2008 GFC by engaging in a money printing orgy. The effects of which are only starting to be felt. The volume of world trade is declining and the only method left for nominal growth is money printing. Nominal not real growth is all that matters so that banks can extinguish their pouch of non performing loans. The high priests of central banks will provide this growth at whatever social and or economic cost.

China “rescued” the world in 2008 by going on a massive credit fueled infrastructure spending spree. The PBOC now must fight the spectre of deflation. The tools at its disposal are rate cuts and currency debasement. Bitcoin and other non-standard risk assets will gain favor with a desperate populace trying to escape the jaws of inflation. Short this rally if you must, but cover before you bust.

XBT Spot

$330 dusted, $320 is history, $340 we are almost there. That statement is filled with hubris. As a speculator, I would like to see $300 put to the test and pass before I marched towards $400.

The volumes on non-Chinese exchanges have not increased enough at these levels. This week will be a true test. Will the $300 prices bring out the closet buyers. A good indicator will be premiums paid in America on LocalBitcoins. The volume on Coinbase will also be an important barometer. Coinbase operates the largest American Bitcoin brokerage service, and all that volume is passed onto their exchange. The largest trading market for Bitcoin has spoken, but we still need follow on support from the second fiddle, America.

Shorting this rally has proved fatal. If you want to express your bearishness, earn the carry by shorting the BitMEX daily 100x leveraged Bitcoin / USD futures contract, XBT24H, vs. buying spot.

Trade Recommendation:

If you are bearish, sell XBT24H vs. buy spot for a cash and carry arbitrage trade.

If you are bullish, buy weekly 50x leveraged Bitcoin / USD futures, XBT7D, while spot is $325 to $330.

Crypto Trader Digest – Oct 26

27 October 2015 Arthur Hayes

To Print Money Is Glorious

On his southern tour of China in 1992, Deng Xiaoping was credited with uttering “To Get Rich is Glorious”. His program of Socialism with Chinese Characteristics unleashed one of modern times’ greatest transformations in a country’s wealth. Since the early 1990’s, China transitioned from the century of humiliation, to a century of prosperity and growth.

China’s growth over the past two decades is legendary, but underpinning this growth is one of the largest credit expansions in human history. Socialism with Chinese Characteristics is a euphemism for a red printing press. Printing money is as old as centralised government. China being China just did it larger and more in your face than any government in history. Since the 2008 GFC, China’s total debt to GDP has almost doubled to 180%. The gargantuan issuance of debt underpinned the creation of ghost cities and bridges to nowhere.

The great financialisation that began in 1971 when Nixon took America off the gold standard is reaching its expiry date. World growth is slowing evidenced by an across the board slump in industrial commodities. China is a highly levered to the global manufacturing economy, and the state owned banks (SOE) loan books are stuffed with industrial companies’ debt. This debt must be warehoused and rolled over to keep the many zombie SOE’s alive. As a result, the PBOC continues to aggressively ease monetary conditions.

This past weekend the Reserve Ratio Requirement was cut by 0.50%, and the benchmark lending rate by 0.25%. These desperate moves are meant to help banks deal with their toxic loan books. As deposit rates drop, the rush to sell CNY and convert into a higher yielding asset will intensify. The PBOC is clearly telegraphing that the CNY will depreciate in the near term. Mao’s red army is watching and as the they earn less and less at the bank, they will start to embrace risky assets. Bitcoin serves as a central bank put, an electronic means of wealth preservation, and a vehicle to export domestic capital.

$300 is just the beginning. If the China narrative catches hold again, a truly explosive upward price burst will occur. For the more patient traders, consider buying BitMEX’s 25x leveraged March 2016 Bitocin / USD futures contract, XBTH16.

XBT Term Structure

The FOMO was strong this weekend. The amazing China pump to 1950 CNY ignited the inner bull in traders. The short end of the curve shot upwards. The long end barely budged. XBTZ15’s basis was flat, and XBTH16’s basis was up 8% on the week. Traders are still hesitant to believe the rebirth from the $200 to $300 purgatory. That is why the long end has not been bought as aggressively. Many traders expect a $300 breach, and then a quick tumble just like the other two attempts prior.

If the narrative around China grows, the medium term trend for Bitcoin is higher. If $300 can be broken and held for a week, then the FOMO will begin in earnest. Then the long end of the curve will skyrocket. Those patient enough to buy XBTH16 and sell XBTZ15 or spot, will be amply rewarded.

Trade Recommendation:

Buy XBTH16 vs. sell XBTZ15 or spot if you believe $300 can be broken and held for one week.

Dancing With The Daily

If Bitcoin is fun, Bitcoin with 100x leverage is a hell of a party. BitMEX’s 100x daily expiring Bitcoin / USD futures contract, XBT24H, has quickly become our most popular product. Because of the heightened volatility and price rise, the premium intraday has been massive.

The above chart shows the premium of XBT24H over spot for October 25th from 00:00 GMT to 23:00 GMT. 12:00 GMT is the settlement time, and that is why there is a dip. Starting yesterday night during the pump to 1950 CNY, the premium of XBT24H reached 1.75% outright. For a contract that expires in 24 hours, that is massive. I call that the FOMO premium. In a trending market, traders following the trend and momentum will overpay for exposure. This is a perfect opportunity for spot vs. futures arbitrage.

The trade is to sell XBT24H and buy spot. This is not a perfect arbitrage. At certain prices, the short XBT24H’s negative USD gamma will cause a loss for the portfolio. The PNL function is quadratic so we can solve a priori for the two break even points. For this particular trade, break even is below $259.37 and above $337.71. Given the spot price was $293, it is extremely unlikely that XBT24H will settle outside of that range. This is a no brainer trade for an arbitrageur.

XBT Spot

Bitcoin traders have been praying to the goddess of volatility for the entire summer. She awoke with a vengeance this weekend. The price action in XBTCNY reminded me of 2013. The highs were high, and the retrace was violent and swift. XBTCNY touched 1950 (appx. $306), and then careened lower by 120 CNY to a low of 1830 this morning.

Bitstamp climbed to $296, and during the downdraft briefly touched below $280. The price action will subside this week, and another attempt will be made for $300 on XBTUSD, and 1950 for XBTCNY. Additional easing from the PBOC will lend the China narrative further firepower. Make no mistake, this is a healthy rally. Short at your own peril.

Trade Recommendation:

Buy the weekly 50x leveraged Bitcoin / USD futures contract, XBT7D, while spot is $280 to $285. The upside target price is $300.

Crypto Trader Digest – Oct 19

19 October 2015 Arthur Hayes

BitMEX Smashes Volume Records

The launch of the 100x daily Bitcoin / USD futures contract, XBT24H, corresponded with a surge in intraday price volatility this weekend. The result was a massive surge in trading volumes on BitMEX. This weekend, we hit a high of 29,000 Bitcoin traded over a 24 hour period. We want to thank all of our traders for helping to make BitMEX one of the most liquid exchanges to trade Bitcoin / USD. If you have not tried out XBT24H, you can take it for a spin on the BitMEX Testnet before trading with real Bitcoin.

We are working diligently to improve the trading experience. We received many great suggestions for new features and UI design change requests. Look out for further announcements about upgrades to the platform.

The Case For CNY Devaluation

Whether or not the recent pump to 1835 CNY and subsequent dump to 1700 CNY is attributable to the MMM ponzi scheme, the premium of XBTCNY to XBTUSD continues to slowly rise. The PBOC resumed the CNY devaluation last Friday, and continued today. Each day at 9:15am Beijing time (GMT + 8), the PBOC releases the CNY Interbank Rate. The Interbank Rate is the rate at which banks can buy and sell CNY against the PBOC. The USDCNY and USDCNH (offshore CNY) follow the trend of the official interbank rate.

The PBOC has allowed the CNY to strengthen vs. the USD and more importantly their trade rivals Germany (EUR), Japan (JPY), and South Korea (KRW) for years. Now with global growth slowing, and the aggressive money printing from Japan and Europe, China’s hand has been forced. Xi Jinping’s biggest economic goal is to shift China away from an investment led economy to a services and consumption lead one. Many politically important groups will be impoverished by the shift in economic focus. A way to cushion the blow to the manufacturing sector is to weaken the CNY.

While the CNY was strengthening, the most popular carry trade was to borrow USD, FX into CNY, then buy bonds yielding significantly more than the cost of USD funds. Because the PBOC had a one way policy of CNY appreciation, carry traders did not forward hedge USDCNY. If they had hedged, the USDCNY forward premium would wipe out most of the profit. These carry traders profited off the PBOC who sold CNY and bought USD. The PBOC’s USD assets, mainly US treasuries, have much lower yields than comparable CNY debt. The easiest way to import USD into China was to fake invoices; this allowed individuals and corporate to FX more USD into CNY than allowed by the PBOC.

The one way CNY appreciation is now over. The carry traders are rushing for the exits, and the PBOC has put up the road blocks. Banks are now enforcing the yearly $50,000 FX limit; overseas UnionPay withdrawals are limited to 100,000 CNY per year; money changers, who previously would help move CNY in and out of China, have been shut. With capital trapped onshore, the PBOC can now devalue the CNY without suffering a loss in China’s capital account.

With the easy and cheap means of moving CNY out of China closed, Bitcoin presents a legal and viable option. The premium of XBTCNY and XBTUSD has begun rising ever since the PBOC devalued the CNY by 4% in August. If this hot money leaks into Bitcoin, the premium and price will shoot higher.

The top chart shows the XBTCNY premium vs. the PBOC Interbank Rate. The premium rose as USDCNY moved higher (read: CNY devalued). The bottom chart shows the premium vs. Bitstamp XBTUSD. As the premium rose, XBTUSD rose as well. These are the most important charts in Bitcoin. China drove the 2013 Bitcoin bubble. The PBOC isn’t done yet. The CNY will weaken, and as it does Bitcoin will slowly leak higher.

This process will happen either slowly or all at once. To take a longer term bullish view on the devaluation, consider buying the BitMEX March 2016 25x leveraged Bitcoin / USD futures contract, XBTH16.

XBT Term Structure

Volatility spiked over the weekend during the China pump and dump. As a result, the term structure parallel shifted upwards. All contracts became more expensive, with shorter dated contracts experiencing the greatest shift upwards. There is a liquidity premium for shorter dated contracts, and that is why they tend exhibit more basis volatility.

The term structure has now become inverted. XBTH16 looks quite cheap in comparison to its peers. XBTH16’s basis only increased 9%. Given the time value this contract still retains, it should increase the most if the price volatility continues. If the curve flattens, XBTH16 should trade at 60%, an increase of 10% annualised. If the curve steepens, XBTH16 could trade at 70%, an increase of 20% annualised.

Trade Recommendation:

Buy XBTH16 (March 2016) vs. sell XBTZ15 (December 2015) to bet on the annualised basis of XBTH16 rising.

XBT Spot

The stair step rally continued into last Friday’s settlement. Then Saturday early morning China time, a pump began. XBTCNY reached a high of 1835. At the pump’s peak, the premium in China was 10%.

The price languished above 1800 CNY, then dumped late Sunday night to a low of 1706 CNY. The rally that started a few weeks back is not over. $260 held on Bitstamp, and China has remained above 1700 CNY. After the weekend fireworks, expect a period of consolidation between $260 to $265. A break below $260 on decent volume will put pause in the rally. If the price can hold above $270 for 24 hours, a run to $300 is likely.

Trade Recommendation:

Buy October 2015 25x leveraged Bitcoin / USD futures contracts (XBTV15) while spot is $260 to $265. The upside target price is $270 and then $300.

The Most Important Chart In Bitcoin

14 October 201514 October 2015 Arthur Hayes

The PBOC is back at it again. Today they devalued the Yuan by the most in 2 months. Their first shock and awe campaign sliced 4% off the Yuan’s value vs. the USD. Then the PBOC sold US Treasuries to support the CNY in the open market.

Since August, the PBOC has been hard at work stemming the enormous flow of capital fleeing China. The $50,000 per year FX limit is beginning to be enforced by banks. There is now a yearly 100,000 CNY limit on overseas UnionPay withdrawals. And I have heard anecdotal stories about the closure black market CNY / HKD money changers in China and Hong Kong.

Today’s action might be the resumption of the devaluation trend the PBOC embarked upon this summer. With the closure of the easy, cheap, and convenient ways to squirrel cash out of China, Bitcoin becomes more attractive. If Bitcoin emerges as a legal means to export capital out of China, the premium for it onshore in China will rise.

In my post China Bitcoin Premium Points To Moon, I presented a one month chart of the Bitcoin premium (OKCoin XBTCNY vs. Bitstamp XBTUSD) starting August 30th. The above chart is an extension of that time series. The premium dipped to 1%, but during the recent rally has resumed its climb above 2%. If this premium continues to rise above 5%, then we know China truly appreciates Bitcoin’s potential as a means of wealth preservation.

If the PBOC renews its devaluation of the Yuan, watch this chart closely. A lot of money through a small door will spell riches for those positioned correctly.

China Bitcoin Premium Points To Moon

29 September 2015 Arthur Hayes

During the November 2013 Bitcoin bubble, the belief was that Chinese people would rush to convert their RMB into Bitcoin to escape the financial repression they faced at home. That did not come to pass as it was still very easy and cheap to spirit capital out of China. That all changed this summer when the PBOC shocked the world by devaluing the CNY by 4% over one week.

The PBOC did not stop there. The Chinese government is aggressively trying to stem the capital flight out of China. Many real estate commentators have lamented how Chinese buyers have slowed down the pace of property purchases because of the increasing difficulty they face exporting their RMB.

In my article Hello Bitcoin: China Begins Enforcing Capital Controls, I speculated on the potential impact on the Bitcoin price if for the purposes of real estate Chinese buyers began using Bitcoin to export their wealth.

The first signs of a possible shift of wealth from China outwards through Bitcoin will be the premium of BTCCNY to BTCUSD. The above chart shows the 24 hour moving average of the premium between Bitstamp (BTCUSD) and OKCoin (BTCCNY) over the past 30 days. While the absolute premium at the present moment is not large, the trend is up and to the right. I plotted the premium against the price of Bitcoin. The two exhibit no correlation over this 30 day time period; however, I predict that if premium continues to rises, it will lay the groundwork for a moon shot.

In the 3% to 5% premium range, it becomes worthwhile to buy offshore, sell onshore in China, and remit money between China and Hong Kong. The difficult step is bringing CNY from China into Hong Kong. If you cross the border between the two territories the legal limit is 20,000 CNY (3,000 USD). At a 5% premium that is a 150 USD gross profit before exchange fees and bank wire fees. That isn’t compelling. This trade needs to be done in a size >$10,000 on a daily basis and electronically. Previously there certain individuals who would take CNY onshore in China and remit you HKD or USD offshore into Hong Kong in any size.

If truly the traditional avenues of moving money between China and Hong Kong have been shut, then the premium will rise above 5%. That presents a clear signal that there is an imbalance of demand to sell CNY and buy Bitcoin. That is when the rocket ship will ignite.

Crypto Trader Digest – Sep 7

7 September 2015 Arthur Hayes

Brokedown Palace: EM FX

As a Hong Konger with essentially USD (HKD is pegged to the USD), my travels around Asia have gotten much cheaper lately. The Chinese started the party by devaluing the CNY. Subsequently traders took the hammer to emerging market (EM) currencies and many worry a repeat of the 1997 Asian Financial Crisis is upon us.

Talk about volatility, a few weeks back Kazakhstan decided enough was enough and let the Tenge (its currency) fall by 22% in one weekend, annualise that! Meanwhile sleepy Bitcoin has been locked in a tight trading range, and volatility is at historic lows. If Empress Yellen decides to raise rates, the EM FX complex will take another drubbing.

Many EM countries and corporates issue debt in USD not their local currency. Investors understandably don’t want EM FX exposure. Many of these countries are either goods or commodity exporters. The current world economy is characterised by slowing world trade, falling demand for industrial commodities, and a strong dollar. This toxic mix ensures that EM countries and corporates will struggle to pay back USD denominated debt. FX traders see the structural balance of payments problems and continue dumping EM currencies, further exacerbating the problem.

Governments valiantly fight against the global markets by selling down their FX reserves of USD denominated assets. Notable examples are China and Saudi Arabia. At some point smaller nations will have to throw in the towel and allow their currencies to weaken drastically. Regular citizens need not sit back and watch their purchasing power destroyed. Diversifying a portion of their wealth into Bitcoin now, is an intelligent decision. Non-USD Bitcoin exchange rates will begin trading a substantial premiums reflecting the market’s view on the future devaluation that will occur in a particular currency. Get out now while the getting is good.

For readers who are in EM countries and can trade deliverable FX forwards here is a trade idea:

Buy Bitcoin, sell USD at one of the big global exchanges.
Sell Bitcoin at a premium, buy your local EM currency. You now have EM currency that you need to convert back into USD.
Buy a deliverable forward (DF). You will deliver EM currency and receive USD when the DF expires. Now you have USD, wash, rinse, and repeat.
The premium that Bitcoin trades to your local currency must be greater than the premium on the DF for this trade to work.

Tongzhimen Hao (Greetings Comrades)

The whole world now hums to the tune of Zhongnanhai. Xi Jinping put on a powerful parade last Thursday commemorating their “victory” (read: the US and Russia saving their ass) in WWII. However the markets didn’t care, and the Shanghai Composite closed down over 2% today. In addition they continue to fix the CNY stronger, which necessitates the PBOC to sell even more US Treasuries to support their currency.

Bitcoin traders should be watching the China equity, FX, and rates markets like a hawk. Knowing the change in the daily PBOC fix of USDCNY is a must. Up until now the beauty of day trading Bitcoin was that the fundamentals (if there are any) mattered little. The ability to correctly read a chart and the human emotion it conveyed easily conveyed profits upon the punter. As a global financial catharsis courtesy of China is at hand, clueless traders will be caught out by economic data points. Dust off that textbook and educate yourself before you rek yourself.

They keys data points are:

USDCNY Exchange Rate
Daily change of the Shanghai Composite
The 10yr US Treasury Yield

Dramatic changes in any of these variables will begin to have a noticeable impact on Bitcoin just like they do for gold.

XBT Term Structure

The curve shifted slightly lower in the past week. Given the price rise, this is surprising. The non-linear return in USD for being long the XBT series futures should have lead to an increase in their premium over spot. Long-end futures (Dec15 XBTZ15 and Mar16 XBTH16) look very cheap. If the rally continues and enters the fomo phase, the long end futures will become much more expensive. Traders who wish to profit from a parallel shift upwards due to a rising price should buy XBTZ15 or XBTH16.

XBT Spot: Breakout

The sleepy 4-day holiday weekend in China culminated with a breakout on Sunday (it was a working day). Bitcoin broke through $230 and traded as high as $248 on Bitfinex. Now the price languishes at $240.

The rally started at $200 and the channel will culminate at $260. $260 is where the previous breakdown in price occurred. Expect price to stall at $240 and trade down into the mid $230’s. If $235 is broken on the downside consider this rally over and ride the rollercoaster back to $220. If $235 can hold, the rally can continue to stair step higher to $250 then $260.

The resistance at $260 will be fierce and in the absence of a new development, the price will not ascend this mountain. China continues puking even after the government has sounded the all clear. Expect more gyrations in the financial markets that could be very positive for Bitcoin if investors view it as a new safe haven.

Trade Recommendation:

Buy XBTU15 (BitMEX weekly Bitcoin/USD futures contract) while spot is $235-$240. The upside target is $255-$260.

The World Is On Holiday, Time For A Bitcoin Dump Or Pump

3 September 2015 Arthur Hayes

This weekend culminates the end of summer, and China’s 70th anniversary of its victory over Japanese aggression. China the most important market in terms of Bitcoin trading has a four day holiday until Sunday September 6th. This weekend is Labor Day weekend in America and Monday September 7th is a bank holiday.

While the majority of the world’s traders are watching national propaganda parades and grilling burgers, the Bitcoin market will remain open. The thin liquidity presents the perfect opportunity for a market operator to push the market aggressively in one direction using little capital. If I were to conduct a bear raid or short squeeze, I would choose this weekend to execute the operation.

Bitcoin has been trapped in a $225 to $230 range during this week’s trading. The Bitfinex swap market does not point to any gross mismatch between leveraged longs or shorts. When Bitcoin breaks out of this range the movement will be swift and momentum traders will be able to join the ride.

Scenario 1: A break above $235

A solid break above $235 on above average volume will lead to a swift move through $240 to $250.

Scenario 2: A break below $220

A solid break below $220 on above average volume will lead to a swift move downwards towards $200. $200 is unlikely to fall again, and another swift rebound to the high $210’s is expected.

Timing:

The optimal time to execute the strategy would be Saturday. US traders will be settled in on their long weekend holidays and this is the last day of the China holiday. This will be the lowest level of liquidity this weekend. It will be very easy to push the market and ignite the momentum bots to follow the trend.

Trade Recommendation:

Buy BitMEX September 25x leveraged futures (XBTU15) if spot breaks above $235. The upside target price is $250.

Sell BitMEX September 25x leveraged futures (XBTU15) if spot breaks below $220. Cover the short at $200, then go long with an upside target price of $215.

China Devalues Yuan, Bitcoin To Da Moon

11 August 2015 Arthur Hayes

In the August 10th Crypto Trader Digest, I predicted the PBOC would devalue the Yuan to regain export competitiveness. Less than 24 hours after hitting the press, the PBOC shocked the market with a 1.9% devaluation. Global macro will be tilted on its head now that the world’s largest export regime is actively engaging in currency debasement.

The RMB is one of the largest globally traded currencies and it’s importance in global capital flows cannot be underestimated. Bitcoin, which is a financial and speculative asset, will be affected as well. Chinese households are now faced with a very painful question, how to protect and grow their saved capital.

Stock market and real estate investments have soured. Households are unable to invest abroad due to capital controls (the elite always could, but I am talking about regular folks). Due to a depreciating Yuan, imported goods will become more and more expensive. They must find a way to convert their paper wealth into real assets that cannot be devalued by the central government. Alternative means of investing will become more and more prevalent. P2P loans, wealth management products, and crypto currency will be three alternative areas where Chinese households will rush to convert Yuan into some form of wealth preserving asset.

The PBOC stated this was a one off devaluation. If anyone believes that, I have a ghost city in China to see you. China is mercantilism on steroids. Kuroda-san’s BOJ printing press will now go into overdrive. Mario Draghi will have no choice but use the cover of Grexit to unlease Euro QE. Each successive devaluation by its exporting peers will be met with force from the PBOC. Chinese speculators recognise this, and they will begin selling and borrowing CNY to buy any risk assets they can get their hands on.

It is time to back up the truck and buy buy buy Bitcoin. The $40 fall from $300 is a blessing. Coins can now be bought at much cheaper levels. To obtain long exposure, buy BitMEX December 2015 futures, XBTZ15.

Crypto Trader Digest – August 10

10 August 2015 Arthur Hayes

Bye Bye, New York State

I am sad to announce that due to Bitlicense, BitMEX will cease to service New York State residents. Residents of New York State will be barred from accessing BitMEX as of August 16 12:00 GMT. Affected users must close all positions and withdraw any Bitcoins held with BitMEX. Users who are unable to access their accounts after August 16th, can email support@bitmex.com to request their positions be closed at prevailing market prices, and their remaining Bitcoin balance withdrawn to a Bitcoin address of their choice.

BitMEX Launches World’s First Ethereum Derivative

Last Friday, Ether (the token powering Ethereum smart contracts) began trading on selected exchanges. Traders smart enough to buy at the IPO price were immediately up 20x on their investment. As expected, many attempted to rush for the exit and crystalise a profit. The problem was that exchanges were not crediting Ether balances and allowing traders to sell.

The launch of the BitMEX Ether / Bitcoin Weekly Futures Contract (ETH7D) coincided with spot trading launch. Because Bitcoin is used as margin, traders can short Ether and lock in their profit without depositing Ether with BitMEX. ETH7D immediately began trading at a substantial discount to spot. ETH7D represented the only mechanism for true price discovery of Ether’s value. The chart above illustrates this point. As each successive wave of Ether deposits were allowed to be sold, spot gapped down attempting to reach the level of ETH7D.

Holders of Ether from the IPO who have not liquidated yet are still in the money. Given the technical problems associated with the launch of new cryptocurrencies, it is likely that transfers and the sale of Ether for Bitcoin or USD could be halted again. ETH7D represents the only way for holders of Ether to lock in a Bitcoin profit.

Here is how to execute the hedge:

Each ETH7D contract represents 1 Ether (ETH). The contract references the Kraken ETHXBT exchange rate and profit and loss are denominated in Bitcoin.
If you bought 10,000 ETH at a price of 0.0005 ETHXBT at the IPO, you must sell 10,000 ETH7D contracts to lock in your profit.
If ETH7D trades at 0.0025, you have locked in a profit of (0.0025 – 0.0005) * 10,000 = 20 XBT.
BitMEX allows 5x leverage for ETH7D. You must deposit 20% * 10,000 * 0.0025 = 5 XBT as margin to place the sell order.

BitMEX ETH7D futures are not purely a speculative product, but have uses for ETH holders who wish to hedge their holdings. If you have any questions about how to hedge your ETH IPO allocation, please contact us.

Global Macro Musings

Germany, Japan, South Korea, and Taiwan, listed in order of importance, are four of China’s largest export competitors. The commonality amongst these countries is the race to the bottom in terms of currency debasement. While the Greek drama has torpedoed the Euro, the German export juggernaut is humming along as EURUSD has fallen from 1.5 to under 1.1. Kuroda-san and his BOJ have trashed the Yen from 80 to 120 in the last two years.

Xi Jinping and the politburo recognising the challenges facing the Chinese economy, are attempting to engineer a transfer of wealth from heavy investment industries into the hands of households. The chief conduit of change is removing the implicit subsidy of an undervalued Yuan. The Yuan is on a tear vs. the global major trading currencies, the USD, EUR, and JPY.

Unfortunately, the world economy isn’t cooperating with China’s rebalancing strategy. World trade is faltering and the commodity complex is imploding along with it. People don’t want more stuff, and China’s growth rate by some estimates has fallen to sub 5% (the official GDP is 7%, but no one believes those numbers). NPLs are rising and deteriorating local government finances have forced the PBOC to warehouse more and more toxic paper. At some point China will have to respond tit for tat vs. its major trade partners to recover some competitiveness and provide succor to its economy by devaluing the Yuan.

Chinese households that experienced a rise in global purchasing power will not sit quietly during a devaluation. They will invest / speculate on goods they believe will protect their wealth. Bitcoin is one piece of the puzzle. While it is not an income bearing bond or asset, Bitcoin cannot be devalued by diktat. When RMB begins to flood the Middle Kingdom, it will find its ways into various non-standard assets and cryptocurrencies will benefit. The Litecoin ponzi scam will be the tip of the iceberg. A desperate population is prone to believe many tall tales, and promoters will capitalise on this desperation and greed.

Quantifying Quanto: XLT7D

BitMEX launched the world’s only Litecoin futures contract that uses Bitcoin as the margin, profit, and loss currency last Wednesday. Because traders are accustomed to trading the LTCUSD exchange rate, we decided to apply a Bitcoin multiplier to the LTCUSD exchange rate. As a result, XLT7D is classified as a quanto futures contract. Many users are still confused as to the implications of quanto vs. non-quanto futures contracts from a pricing perspective. I intend to walk readers through a simple example meant to illustrate how to properly price the quanto risk premium.

Assume that a trader has gone short XLT7D futures contracts. He is now short Litecoin, long USD, and his profit will be in Bitcoin. He decides to hedge his short LTC exposure by buying LTC on the spot market. His LTC and USD exposures as it relates to price movements are now hedged. However, his XLT7D pnl is denominated in Bitcoin while his LTCUSD pnl is denominated in USD. If LTCUSD rises he will be short XBTUSD from a pnl perspective, and if LTCUSD falls he will be long XBTUSD.

The question now becomes, what is the covariance between LTCUSD and XBTUSD. Covariance measures the degree to which two assets move together. I took daily log returns of XBTUSD and LTCUSD from Bitfinex and calculated the covariance over a 30 day period. The result was a positive covariance of 0.068% or 6.8 basis points. Therefore, XLT7D should be priced 6.8bps cheaper than LTCUSD. The adjustment is so small that it can be safely ignored. Traders can treat the quanto XLT7D future as they would a LTCUSD future. The upside is that XLT7D’s settlement currency is Bitcoin, which doesn’t necessitate the holding of Litecoin or USD.

XBT Futures Term Structure

When I used to be an ETF market maker, there was nothing more exhilarating than taking a large outright position in particular stock. I used to run overnight mean reversion strategies in certain ETFs between the NY and Asian time zones. I would wake up with substantial deltas and have to close out at market open. That only occupied me for a few hours each day. More fun and risk was to be had, playing basis curves between various equity index futures. Now that there is more volume going through BitMEX’s XBT series contracts, curve trades can be executed.

I will begin posting the WoW changes in the XBT futures term structure. The term structure illustrates the % basis per annum each maturity futures contract is trading at. I take a 24 hour average of the % annualised basis each Sunday. Traders who do not wish to predict the outright movement of Bitcoin, may instead trade the relative movement in the term structure.

The curve experienced a parallel shift downwards WoW. To sell basis or go short interest rates, traders would need to sell XBT futures contracts and buy spot. As the spread narrows, unwind the trade for at a profit.

XBT Spot

The downdraft I had called for finally occurred. A swift fall took the price to $260. The all-important support level held, and now the $260-$270 chop has begun. The Grexit premium has all but evaporated. The $300 bag holders can now hold a “cheap coins” symposium on an r/bitcoin thread.

$260 will be tested again. Failure to hold that level will most likely result in a retest of $220. If Bitcoin can hold firm during the final days of August, the return of traders from summer holiday should buoy the market.

Trade Recommendation:

Sell XBTQ15 while spot is above $265 with a near-term target price of $260. If that breaks, the next target is $240.

Fall 2015: The Empire Of Chaos And Bitcoin

6 August 2015 Arthur Hayes

The financial markets have largely forgotten the pain experienced during the GFC. This time around with 0% interest rates and free money galore, all sorts of risk assets have been buoyed. Bitcoin came about during the depths of the GFC depression. Bitcoin at its core is a reaction against ways in which mainstream finance has been practiced over the past 100 years. Bitcoin feeds off of investors dissatisfaction with monetary and governmental regimes.

After 7 years of free money, cracks in the world economic edifice are beginning to show. I have identified three salient areas where instability might flare up this fall. While I can’t predict the exact response of global assets in each scenario, I am willing to wager that Bitcoin will benefit from chaos and instability.

The Federal Reserve Rate Hike

The Fed aggressively lowered interest rates and printed money via quantitative easing starting in late 2008. Now they are determined to show the world that they can raise interest rates and recover some of their tattered credibility. Through different mediums they have loudly telegraphed that 0.25% rate rise will happen by year end. The financial media has touted the party line that the US economy and in particular equities can handle positive short term rates.

I disagree strongly. When discounting any asset at 0%, even a small rise wrecks havoc on any discounted cash flow analysis. Even more troublesome, is what happens to companies who must now roll low interest debt into higher yielding debt. That is not a problem when the general business climate is improving. However, the collapse in the commodity complex tells us that end demand and real economic activity is falling worldwide. Many businesses only exist because yield starved investors have financed them at ridiculously low interest rates.

Important Dates:

Federal Reserve Open Market Committee (FOMC)

September 16-17

October 27-28

December 15-16

Grexit And Eurozone Turmoil

After Alexis Tsipras acquiesced to Germany’s bloodless coup, Grexit was temporarily taken off the table. For ordinary Greeks, the situation has become worse. Capital controls still remain, and business activity is grinding to a halt. Greece might still need a “time out” from the Eurozone to shave its unserviceable debt load.

Once European bureaucrats return from their Mediterranean beach holidays, the uncomfortable truths of a troubled Eurozone will appear once more. Spain and Poland have national elections this fall. Anti-EU parties are gaining strength. PM Rajoy’s People’s Party is being assaulted by Pomedos. Pomedos is campaigning on an anti-austerity framework. If Greece is able to receive debt relief, Pomedos will campaign for similar tactics to be employed by Spain.

Polish MP’s are up for re-election this fall. Dissatisfaction with the EU program could lead to a change in the makeup of parliament. Given that many of the EU bailout programs need domestic approval before the commitment of funds, a hostile parliament can spell trouble for Brussels.

Important Dates:

Polish elections October 25

Spanish elections before December 20

China

The drama surrounding the correction in the Chinese equities market, while entertaining, is not the main event in the Middle Kingdom. The real problems facing China are accelerating CPI food inflation, a slowdown in economic activity, and the mass exodus of capital.

Once you get past the glittering luxury store fronts on the eastern seaboard, Chinese poverty rears its head. The mass of poor people spend a significant amount of their disposable income on food, especially pork. Pork prices have been on a tear this year. Beijing and the PBOC are acutely aware of how food inflation impacts the majority of its citizens. The legitimacy of the Chinese Communist Party (CCP) is at risk during period of high inflation. As a result, the PBOC is hesitant to aggressively cut interest rates for fear of stoking inflation. Instead to prop up the faltering stock market, they must resort bans on selling stocks and directly buying the market.

Beijing recognises that China must transition from an investment to a consumer driven economy. The 10+% GDP YoY gains are a thing of the past. Many economists believe 3%-5% GDP growth is coming. Unfortunately the vast amount of debt underpinning many businesses and local governments need a high nominal GDP growth rate to paid back. The PBOC now must absorb these non-performing loans at a time when they can’t cut rates due to inflation fears. At some point, the government will have to allow selective entities to default and that will send a ripple through the Wealth Management Product (WMP) industry. WMP’s are high yielding debt instruments with implicit guarantees of the issuing banks and or local governments. If investor confidence is shaken in WMP’s, these funds will need to find a new investment vehicle (maybe Bitcoin?).

Finally, the capital flight from China is accelerating. The elites recognise the precarious state of the Chinese economy and their position in it. They are sending their spawn to America, Canada, Australia etc. to deploy RMB into real estate and other assets. The capital account of China is closed only to those without the right Guanxi (read connections). The PBOC has begun selling US Treasuries to offset the flow of capital out of China. If Beijing actually cracks down on the porous nature of the capital account, these funds will need to find another way to escape the RMB and China. Bitcoin is one option. It is still too illiquid to handle the tens of billions USD leaving the country each month, but even a small percentage of these flows going through Bitcoin could lead to a massive price rise.

The RMB strengthened against the USD and other Asian trading rival’s currencies for the past few years. Faced with the set of domestic financial challenges described above, the PBOC at some point may begin devaluing the Yuan. Chinese investors who want to protect against depreciation can turn to Bitcoin to protect a portion of their wealth.