BitMEX Launches Bitcoin Volatility Futures Contracts

We are proud to announce the launch of the world’s first Bitcoin 30 Day Historical Volatility Futures Contract (BVOL). The product will allow traders to speculate on the 30 day historical volatility of Bitcoin / USD as observed on Bitfinex. Traders will now be able to profit on the increase or decrease of Bitcoin price volatility without taking a position in the exchange rate.

Wikipedia defines volatility as, “a measure for variation of price of a financial instrument over time. Historic volatility is derived from time series of past market prices.” BitMEX has constructed a 30 day historical volatility index by taking the daily 10:00 GMT – 12:00 GMT 1 minute Time Weighted Average Price (TWAP) for Bitcoin / USD on Bitfinex. Each daily index value represents the realised volatility over the past 30 days. The futures contract on settlement day will equal the index value on that day.

The futures contracts have the symbol BVOL and expire on the last Friday of every calendar month at 12:00 GMT. The contract is quoted in annualised volatility % points. A futures price of 50.00 corresponds to an annualised volatility of 50.00%. For each 1% point movement, traders stand to make or lose 0.01 Bitcoin.

The futures contracts will be margined the same as all other BitMEX futures contracts. Initially up to 5x leverage will be allowed on this product. Margin, profit, and loss are all denominated in Bitcoin. As the liquidity grows, we will gradually increase leverage on this product.

XBT vs. XBU Chain

Note: This information is outdated. From 2014 to 2016, BitMEX had both quanto and inverse offerings. To simplify our products, we moved to inverse-only.

For up-to-date information, see the XBT Series Guide.


BitMEX‘s goal is to provide the most complete Bitcoin derivatives product offering. There are currently two types of popular structures, quanto and inverse. The XBTUSD swap product uses the inverse structure, and the XBTU16 contract uses the quanto structure.

XBTUSD is worth $1 of Bitcoin at any price. XBTU16 has a fixed Bitcoin multiplier of 0.00001 XBT per $1. Both contracts are quoted in USD and referencing the Kaiko BitMEX Index Bitcoin / USD (XBTUSD) spot rate.  The below table summarises XBTUSD and XBTU16:

Symbol XBTUSD XBTU16
Type Inverse Quanto
Underlying 1 / XBTUSD or USDXBT XBTUSD
Multiplier -$1 0.00001 XBT
Quote Currency USD USD
Margin & PNL Currency XBT XBT
Maturity No Expiry 30 September 2016
Settlement Mechanism Unrealised profits and losses are rebalanced daily at 12:00 UTC 10:00 UTC – 12:00 UTC 1 minute TWAP on Kaiko BitMEX Index
XBT Value of 1 Contract 1 / Price * $1 Price * 0.00001 XBT
USD Value of 1 Contract $1 Price² * 0.00001 XBT
XBT PNL of 1 Contract (1 / PriceT – 1 / Price0) * -$1 (PriceT – Price0) * 0.00001 XBT

The XBTUSD is an inverse contract because it is quoted as XBTUSD but in actuality the underlying is USDXBT or 1/XBTUSD. It is quoted as an inverse because most traders in the Bitcoin community are accustomed to seeing Bitcoin quoted as the home currency. This product is suitable for traders who need to lock in a USD value of Bitcoin. If you were to receive $100,000 of Bitcoin in three months, you would sell 100,000 XBTUSD contacts to lock in the $100,000 value.

The XBTU16 is a quanto futures contract because it is quoted in USD but the multiplier is in XBT. From Wikipedia:

A quanto is a type of derivative in which the underlying is denominated in one currency, but the instrument itself is settled in another currency at some fixed rate.

This chain is suitable for traders who have Bitcoin and want to earn Bitcoin by correctly predicting the future price of Bitcoin.

xbt_xbu_1

The chart above displays the USD and XBT exposure of being long 1,000 XBTUSD contracts as the XBTUSD spot rate changes. The USD exposure is constant at $1,000; however, the XBT exposure changes in non-linear way because you are taking the inverse of the XBTUSD price [XBT Value = 1/Price * $1 * Contracts]. The next chart shows the margin implications.

xbt_xbu_2

Assume you bought 1,000 XBTUSD contracts at a price of $500. The XBT value of those contracts is 1/$500 * $1 * 1,000 or 2 XBT. Being a cautious trader, you deposited 2 XBT as margin. You assume because you have fully margined the position that you cannot go bankrupt if the price drops. The chart above shows that you are incorrect. The blue line shows your 2 XBT of equity. The red line shows the PNL from the long 1,000 XBTUSD contracts. The green line shows your net equity after netting your PNL. Your account actually goes into negative equity a.k.a. bankruptcy as the price drops below $300. Because XBTUSD is an inverse contract, when you buy 1,000 contracts you are actually short USDXBT – not long XBTUSD – and as a result when the XBTUSD price drops, your account can be margin called even if you deposited the full XBT notional value of your position.

xbt_xbt_3

The chart above displays the USD and XBT exposure of being long 1,000 XBTU16 contracts as the XBTUSD spot rate changes. The XBT exposure changes linearly with respect to XBTUSD. The USD exposure changes in a non-linear fashion because the Price variable is squared [USD value = Price² * 0.00001 XBT * Contracts].

xbt_xbu_4

xbt_xbu_5

One chain is clearly better than the other depending on your view of future XBTUSD prices. The two charts above show the XBT and USD PNL assuming a portfolio of long 1,000 XBTU16 contracts and short 2,500 XBTUSD contracts both at a price of $500. At $500 the XBT and USD value of the two products is equal. If you have a bearish view on the XBTUSD price, going short XBTUSD is the optimal strategy. If you have a bullish view on the XBTUSD price, going long XBTU16 is the optimal strategy.

Future vs. Future Arbitrage With The XBU Chain

Arbitrage between different futures contracts with similar underlyings and payoff structures can be a very profitable trading strategy. The most common futures contract structure in Bitcoin is worth a fixed amount of USD and pays out in Bitcoin. BitMEX, OKCoin, BitVC, and ICBIT all have futures contracts using this structure.

BitMEX offers a XBU chain where each contract is worth $100 in Bitcoin, and quoted in USD. As the spot Bitcoin (XBT) / USD exchange rate moves up and down the contract’s worth stays fixed at $100. If you are long the contract, as the XBT/USD price rises the contract is worth less and less XBT; as the XBT/USD price falls the contract is worth more and more XBT.

The goal is to find two futures contracts that have similar structures. The below table lists the relevant details on the two contracts.

Exchange BitMEX OKCoin
Futures Contract XBUH15 BTC0327
Underlying XBT/USD XBT/USD
Multiplier $100 $100
Expiry Date 27 March 2014 27 March 2014
Expiry Time 10:00 UTC – 12:00 UTC TWAP on Bitfinex 08:00 UTC BTC/USD Index (an OKCoin constructed index)
Clearing Method Central Clearing Socialised Losses

The similar payout structure and expiry dates make these two contracts good candidates for arbitrage.

For the following example assume the following:

  1. The Bitcoin price on Bitfinex and the OKCoin BTC/USD Index is $395 and $392 respectively
  2. XBUH15 and BTC0327 are trading at $405 and $395 respectively.

The two contracts trade on different indices so to evaluate the arbitrage potential let’s look at the basis on each contract. Basis = Futures Price – Spot Price.

Futures Contract XBUH15 BTC0327
Futures Price $405 $395
Underlying Spot Price $400 $387
Basis $5 $8

XBUH15’s price is greater than BTC0327’s; selling XBUH15 and buying BTC0327 will yield a profit. But how much? The price differential is $10; however, BTC0327 uses a different settlement index than XBUH15 for which needs to be considered. Because we are selling XBUH15 we receive the basis or +$5, and we pay the basis or -$8 on the purchase of BTC0327. The total expected profit is $10 + $5 – $8 = $7.

At 08:00 UTC on 27 March 2015 the long BTC0327 contracts will expire. The long exposure the contract generated is now gone. From 08:00 UTC to 12:00 UTC, you are short XBT/USD because you sold XBUH15 contracts. For those four hours, you can either buy Bitcoin on Bitfinex and sell during the TWAP settlement period or run the short exposure until the XBUH15 contracts expire. Depending on the execution slippage and market movement the expected $7 profit may be higher or lower.

 

 

BitMEX Hosts Bitcoin Arbitrage Webinar

Bitcoin Arbitrage Webinar

In conjunction with David Moskowitz of Coin Republic, BitMEX CEO Arthur Hayes will be hosting a webinar covering Bitcoin arbitrage trading strategies. The webinar will take place on Monday 27 October 2014 at 20:00 Eastern Standard Time.

Topics covered include:

  • Cash Exchange Arbitrage
  • Futures vs. Spot Arbitrage
  • Covered Interest Rate Parity
  • BitMEX Derivative Contracts

Arthur will explain how traders can employ these simple strategies and make Bitcoin volatility work for their portfolio.
Coin Republic has more details on the webinar.

Materials for the Webinar

If you have not already done so, please visit the BitMEX Testnet and set up an account. Arthur will demonstrate how to properly execute these strategies using BitMEX derivative contracts. 

Please download the Arbitrage Pricing Excel Spreadsheet so that you may follow along. Arthur will describe the math behind the strategies step by step.

BitMEX for Commercial Hedgers

BitMEX is committed to serving the needs of commercial hedgers. Commercial hedgers are merchants or payment processors who accept Bitcoin as payment and need to manage their Bitcoin vs. fiat currency risk. This manual is meant to instruct commercial hedgers on how to use BitMEX derivative products to reduce the currency risk their business faces when they choose to accept Bitcoin as a form of payment.

In this lesson, Bitcoin will be referred to with the three-letter currency code XBT. The Bitcoin / USD exchange rate is XBTUSD. The lesson will explain hedging strategies using three different types of futures contracts: XBT, XBU, and XU futures chains.

The XBT futures chain’s underlying is XBTUSD, the contract has a multiplier of 0.0001 XBT, and is quoted in USD. The value of each contract in XBT and USD depends on the XBTUSD exchange rate. Margin, profit, and loss are all denominated in XBT. This lesson will use the XBTUSD December 26, 2014 futures contract and will be referred to using the symbol XBTZ14. The below functions describe the value of a XBTZ14 contract in XBT and USD:

XBTZ14 Value in USD = 0.00001 XBT * XBTZ14 Price * Contracts * XBTUSD

XBTZ14 Value in XBT = 0.00001 XBT * XBTZ14 Price * Contracts

The XBU futures chain’s underlying is XBTUSD, each contract is worth $100 of Bitcoin and quoted in USD. Margin, profit, and loss are all denominated in XBT. This lesson will use the XBT/USD December 26, 2014 futures contract and will be referred to using the symbol XBUZ14. The below functions describe the value of a XBUZ14 contract in XBT and USD:

XBUZ14 Value in USD = $100 * Contracts

XBUZ14 Value in XBT = $100 * 1/XBUZ14 Price * Contracts

The XU futures chain’s underlying is XBTUSD, each contract is worth 0.01 XBT, and is quoted in USD. Margin, profit, and loss are all denominated in USD. This lesson will use the XBT/USD December 26, 2014 futures contract and will be referred to using the symbol XUZ14. The below functions describe the value of a XUZ14 contract in XBT and USD:

XUZ14 Value in USD = 0.01 XBT * XUZ14 Price * Contracts

XUZ14 Value in XBT = 0.01 XBT * Contracts

For the examples presented below assume the current date is Oct 1, 2014, the XBTUSD exchange rate is $800, and the USDXBT exchange rate is 0.002 XBT.

Merchant Accepts Bitcoin as Payment

The merchant is a shoe wholesaler. Normally the merchant accepts only USD as payment for their goods. Their clients order large quantities of shoes today, but will pay at the end of December. All the merchants costs are denominated in USD, i.e. salaries, rent, supplies etc. For cost savings, the merchant has decided to accept Bitcoin as a form of payment.

By taking Bitcoin for future payment, the merchant must cover their costs today in USD, but receive payment in the future in Bitcoin. The merchant cannot simply sell Bitcoin and buy USD on the spot market because the merchant has not been paid their Bitcoin yet. The merchant needs a derivative solution to forward sell Bitcoin and buy USD to hedge the currency risk until their client pays.

Merchant Hedges Using the XBTZ14 Contract

A client would like to buy $100,000 worth of shoes. Instead of paying in USD, the client would like to pay the merchant in Bitcoin when he receives the shoes on December 26, 2014. The XBTZ14 contract is currently trading $1,000, and spot XBTUSD is $800. The merchant and client must decide on an exchange rate to use for their deal. The merchant decides that because the client will pay for the goods in Bitcoin in the future, the XBTZ14 price should be used as the exchange rate. The below table summarises the merchant’s cash flows:

Today 12/26/2014
USD Costs -$100,000
XBT Receipts 100 XBT

If the XBTUSD exchange rate rises, the merchant will make an additional profit as the XBT they receive in December will be worth more in USD. If the XBTUSD exchange rate falls, the merchant will make a loss as the XBT they receive in December will be worth less in USD. The merchant is short USD vs. long XBT or long the XBTUSD exchange rate.

The merchant uses their account at BitMEX to trade XBTZ14 contracts. The XBTZ14 contract has an underlying of XBTUSD, to correctly hedge their risk the merchant needs to sell XBTZ14 contracts. If one sells the XBTZ14 contract, one is short XBT vs. long USD or short the XBTUSD exchange rate. The following function describes how to calculate the correct number of XBTZ14 contracts to sell:

Contracts = XBT Value to Hedge / (XBTZ14 Price * 0.00001 XBT)

The merchant needs to hedge the 100 XBT they are receiving. The merchant needs to sell 10,000 contracts [10,000 = 100 XBT / ($1,000 * 0.00001 XBT)]. On December 26, 2014, the client pays the merchant 100 XBT and the XBTZ14 futures contracts expire. The below table shows the merchant’s cash flow using different XBTUSD exchange rates observed on December 26, 2014:

XBTUSD XBT Received XBTZ14 PNL XBT Total XBT Total Value USD
$800 1,000 XBT 20 XBT 120 XBT $96,000
$900 1,000 XBT 10 XBT 110 XBT $99,000
$1,000 1,000 XBT 0 XBT 100 XBT $100,000
$1,100 1,000 XBT -10 XBT 90 XBT $99,000
$1,200 1,000 XBT -20 XBT 80 XBT $96,000

As described above, the XBTZ14 contracts pay out in XBT. The merchant must now decide whether they will keep the XBT or convert into USD. The table above shows that the USD value of the merchant’s XBT is not fully hedged. Any deviation from a XBTUSD price of $1,000, negatively impacts the total value of the merchant’s XBT. The XBT futures chain is a quanto derivative. It is linear in XBT terms, but non-linear in USD terms. For more information about quanto derivatives, please read the BitMEX blog post XBUU14 vs. XBTU14.

The Merchant Uses the XBUZ14 Contract

A client would like to buy $100,000 worth of shoes. Instead of paying in USD, the client would like to pay the merchant in Bitcoin when he receives the shoes on December 26, 2014. The XBUZ14 contract is currently trading at $1,000, and spot XBTUSD is $800. The merchant and client must decide on an exchange rate to use for their deal. The merchant decides that because the client will pay for the goods in Bitcoin in the future, the XBUZ14 price should be used as the exchange rate. The below table summarises the merchant’s cash flows:

Today 12/26/2014
USD Costs -$100,000
XBT Receipts 100 XBT

If the XBTUSD exchange rate rises, the merchant will make an additional profit as the XBT they receive in December will be worth more in USD. If the XBTUSD exchange rate falls, the merchant will make a loss as the XBT they receive in December will be worth less in USD. The merchant is short USD vs. long XBT or long the XBTUSD exchange rate.

The merchant uses their account at BitMEX to trade XBUZ14 contracts. The XBUZ14 contract has an underlying of XBTUSD, to correctly hedge their risk the merchant needs to sell XBUZ14 contracts. The XBUZ14 is an inverse contract meaning when one goes short one is actually going long USDXBT (the inverse of XBTUSD). Therefore, if one sells the XBUZ14 contract, one is  long USD vs. short XBT or long the USDXBT exchange rate. The following function describes how to calculate the correct number of XBUZ14 contracts to sell:

Contracts = USD Value to Hedge / $100

Each XBUZ14 contract is worth $100; therefore to hedge a USD exposure of $100,000, the merchant needs to buy 1,000 contracts [1,000 = $100,000 / $100]. The below table shows the merchant’s cash flow using different XBTUSD exchange rates on December 26, 2014:

XBTUSD XBT Received XBUZ14 PNL XBT Total XBT Total Value USD
$800 100 XBT 25 XBT 125 XBT $100,000
$900 100 XBT 11 XBT 111 XBT $100,000
$1,000 100 XBT 0 XBT 100 XBT $100,000
$1,100 100 XBT -9 XBT 91 XBT $100,000
$1,200 100 XBT -17 XBT 83 XBT $100,000

As described above, the XBUZ14 contracts pay out in XBT. The merchant must now decide whether they will keep the XBT or convert into USD. At each given XBTUSD rate on December 26, 2014, the value of the merchant’s XBT holdings is $100,000. By hedging with the XBUZ14 contract, the merchant has eliminated their USD / Bitcoin currency risk.

The Merchant Uses the XUZ14 Contract

A client would like to buy $100,000 worth of shoes. Instead of paying in USD, the client would like to pay the merchant in Bitcoin when he receives the shoes on December 26, 2014. The XUZ14 contract is currently trading $1,000, and spot XBTUSD is $800. The merchant and client must decide on an exchange rate to use for their deal. The merchant decides that because the client will pay for the goods in Bitcoin in the future, the XUZ14 price should be used as the exchange rate. The below table summarises the merchant’s cash flows:

Today 12/26/2014
USD Costs -$100,000
XBT Receipts 100 XBT

If the XBTUSD exchange rate rises, the merchant will make an additional profit as the XBT they receive in December will be worth more in USD. If the XBTUSD exchange rate falls, the merchant will make a loss as the XBT they receive in December will be worth less in USD. The merchant is effectively long XBT vs. short USD, or long the XBTUSD exchange rate.

The merchant uses their account at BitMEX to trade XUZ14 contracts. The XUZ14 contract has an underlying of XBTUSD, to correctly hedge their risk the merchant needs to sell XUZ14 contracts. If one sells the XUZ14 contract, one is short XBT vs. long USD or short the XBTUSD exchange rate. The following function describes how to calculate the correct number of XBTZ14 contracts to sell:

Contracts = XBT Value to Hedge / 0.01 XBT

Each XUZ14 contract is worth 0.01 XBT; therefore to hedge a XBT exposure of 100 XBT, the merchant needs to sell 10,000 contracts [10,000 = 100 XBT / 0.01 XBT]. The below table shows the merchant’s cash flow using different XBTUSD exchange rates on December 26, 2014:

XBTUSD XBT Received XUZ14 PNL USD Total Value USD
$800 100 XBT $20,000 $100,000
$900 100 XBT $10,000 $100,000
$1,000 100 XBT $0 $100,000
$1,100 100 XBT -$10,000 $100,000
$1,200 100 XBT -$20,000 $100,000

As described above, the XUZ14 contracts pay out in USD. The merchant must now decide whether they will keep the XBT received from the client, or convert into USD. At each given XBTUSD rate on December 26, 2014, the value of the merchant’s currency holdings is $100,000. Buy hedging with the XUZ14 contract, the merchant has eliminated their Bitcoin / USD currency risk.

Contango and Backwardation

The future value of any currency pair is determined by the interest rate differential between the two currencies. This means that a Bitcoin futures contract can and does trade at a premium or discount to the spot exchange rate. When a futures contract trades at a premium to spot, the futures contract is said to be in contango. When a futures contract trades at a discount to spot, the futures contract is said to be in backwardation. To understand more about these concepts, please read the BitMEX blog post Bitcoin and Interest Rates.

In all three examples above, the futures price was different from the spot price. A savvy merchant can take advantage of contango and backwardation in the futures contract to earn extra income. Instead of the merchant using the futures price to determine the amount the client pays, the merchant will use the prevailing spot price at the time of the transaction. The client will pay the merchant 125 XBT [125 XBT = $100,000 / $800] instead of 100 XBT. The below tables illustrate for each hedging option, the monetary outcome for the merchant:

Hedging using the XBTZ14 contract, the merchant will sell 15,625 contracts [15,625 = 125 XBT / (0.00001 XBT * $800)].

XBTUSD XBT Received XBTZ14 PNL XBT Total XBT Total Value USD
$800 125 XBT 31 XBT 156 XBT $125,000
$900 125 XBT 16 XBT 141 XBT $126,563
$1,000 125 XBT 0 XBT 125 XBT $125,000
$1,100 125 XBT -16 XBT 109 XBT $120,313
$1,200 125 XBT -31 XBT 94 XBT $112,500

Hedging using the XBUZ14 contract, the merchant will still sell 1,000 contracts as the USD value of the goods has not changed.

XBTUSD XBT Received XBUZ14 PNL XBT Total XBT Total Value USD
$800 125 XBT 25 XBT 150 XBT $120,000
$900 125 XBT 11 XBT 136 XBT $122,500
$1,000 125 XBT 0 XBT 125 XBT $125,000
$1,100 125 XBT -9 XBT 116 XBT $127,500
$1,200 125 XBT -17 XBT 108 XBT $130,000

Hedging using the XUZ14 contract, the merchant will sell 12,500 contracts [12,500 = 125 XBT / 0.01 XBT].

XBTUSD XBT Received XUZ14 PNL USD Total Value USD
$800 125 XBT $25,000 $125,000
$900 125 XBT $12,500 $125,000
$1,000 125 XBT $0 $125,000
$1,100 125 XBT -$12,500 $125,000
$1,200 125 XBT -$25,000 $125,000

In each example, the merchant is earning more money than before. The XBTZ14, XBUZ14, and XUZ14 are all trading at $1,000, while XBTUSD is at $800. Because the merchant is selling these contracts, they are earning an extra $200.

Merchants should always analyze whether the futures contract they use to hedge is in contango or backwardation and price their goods accordingly. An intelligent hedging strategy can allow a merchant to earn additional income.

Margin Considerations

Merchants are only allowed to trade on BitMEX once they have deposited the appropriate margin. Depending on the futures contract, the merchant will either need to post Bitcoin or USD. For XBTZ14 and XBUZ14, the merchant must post Bitcoin as margin. For XUZ14, the merchant must post USD as margin. Depending on the currency composition of the merchant’s working capital, one contract might be more attractive than another from the currency in which margin is posted.

Arbitrage Made Easy, Lesson 1

The Arbitrage Made Easy lessons will present simple yet profitable arbitrage strategies that can be employed by traders using a combination of spot Bitcoin trading and BitMEX derivatives contracts. The Bitcoin/USD exchange rate will be referred to using the symbol XBTUSD.

Lesson 1 will focus on the arbitrage of price differentials between spot XBT exchanges.

After spending some time trading XBT, traders will notice that sometimes there are large differences between exchanges. Savvy traders can capture these price differentials in a riskless manner. This lesson will assume that the trader’s home currency is USD. Therefore, the trader wants zero risk in USD terms. Traders will use a portfolio of USD and XBT to capture arbitrage opportunities risklessly.

During this lesson we will refer to the “cheap exchange” as exchange A, and the “expensive exchange” as exchange B. The goal as with any trade is to buy low on exchange A, and sell high on exchange B.

Step 1: Construct a Portfolio of Half USD and Half XBT

The arbitraging of spot exchange requires traders to buy XBT cheaply on exchange A, and sell XBT expensive on exchange B simultaneously. If a trader started with just USD the following steps would have to be taken to conduct the arbitrage:

  1. Wire USD to exchange A
  2. Sell USD buy XBT
  3. Transfer XBT to exchange B, wait for 1-6 confirmations
  4. Sell XBT for USD on exchange B
  5. Remit USD from exchange B to home bank account
  6. Repeat

There are several problems with that trade flow. Wiring USD can take upwards of 5 business days depending on the bank and country. By the time the funds reach exchange A, the arbitrage opportunity could have disappeared. In step 3, the price of XBT could move against the trader before he is able to sell on exchange B.

The optimal structure would be to have a portfolio of USD and XBT spread out across the relevant exchanges. When an opportunity presents itself, traders can act immediately and capture the arbitrage before it evaporates.

Going forward a XBT spot price of $500 will be assumed. A portfolio of $5,000 and 10 XBT has been constructed. The total portfolio value is $10,000 = $5,000 + 10 XBT * $500.

Step 2: Sell XBT Futures Contracts to Eliminate Price Risk

The home currency is USD, traders do not want to have any exposure to XBT exchange rate fluctuations. Trading BitMEX futures contracts is the best way to eliminate currency risk. BitMEX offers a futures contract that locks in the future USD value of Bitcoin, called the XBU series.

Step 2a: Selling XBUU14 Futures Contracts

Each XBUU14 (BitMEX USD / Bitcoin September 26, 2014) is worth $100 of Bitcoin. The underlying is the XBTUSD spot price. For this lesson, the current XBTUSD price is $500. The current price of the XBUU14 contract is $500. To determine the proper amount of contracts to sell, the trader should consider the USD value of XBT that he wishes to hedge. The current USD value of the 10 XBT held is $5,000 = $500 * 10 XBT. The portfolio needs to sell 50 contracts = $5,000 / $100.

Now the sample portfolio looks as follows:

$5,000 cash

10 physical Bitcoin

Short 50 XBUU14 contracts

The below table shows the USD value of the portfolio as spot XBTUSD changes:

XBTUSD USD Cash Physical XBT XBT Profit XBUU14 USD Portfolio Value
300 $5,000 10 XBT 7 XBT $10,000
400 $5,000 10 XBT 3 XBT $10,000
500 $5,000 10 XBT 0 XBT $10,000
600 $5,000 10 XBT -2 XBT $10,000
700 $5,000 10 XBT -3 XBT $10,000

Because of the XBUU14 hedge, the portfolio value stays constant at $10,000 no matter the XBTUSD price. Now the Bitcoin price volatility will not affect the returns from this arbitrage strategy.

Step 3a: Full Circle Arbitrage Between Exchanges A and B

Now that the portfolio has been constructed and hedged to eliminate currency risk, it is time to capture riskless profits. Exchange A trades at $480, while exchange B trades at $500. The below steps describe how to arbitrage the two exchanges.

  1. Deposit $5,000 onto exchange A; deposit 7 XBT onto exchange B
  2. Buy 7 XBT on exchange A for a cost of $3,360 = 7 XBT * $480
  3. Simultaneously sell 7 XBT on exchange B and receive $3,500
  4. Withdraw $3,500 from exchange B, then wire $3,500 to exchange A
  5. Transfer 7 XBT from exchange A to B
  6. Repeat

The above trade generated $140 in gross profit. USD deposit and withdrawal fees as well as exchange trading fees must be deducted. The result will be the net profit from this arbitrage trade. The amount of times the portfolio can be churned is limited by the speed of USD wire transfers and the size of price gap between exchange A and B.

Notice that only 7 XBT could be used as working capital for the arbitrage opportunity. This is because BitMEX requires margin to be posted against the short 50 XBUU14 contracts. BitMEX requires an initial margin of 30%, given short 50 XBUU14 contracts are worth 10 XBT (1/$500 * $100 * 50 Contracts), 3 XBT must be deposited as margin with BitMEX leaving 7 XBT for arbitrage purposes.

Step 3b: Exchange A and B Spread Trading

Instead of withdrawing USD from exchange B and transferring again back to exchange A, a trader can play the spread between the two exchanges. Exchange A trades at $480, while exchange B trades at $500. The below steps describe how to spread trade.

  1. Deposit $5,000 onto exchange A; deposit 7 XBT onto exchange B
  2. Buy 7 XBT on exchange A for a cost of $3,360 = 7 XBT * $480
  3. Simultaneously sell 7 XBT on exchange B and receive $3,500
  4. Prices on exchange A and B equalise at $500
  5. Buy 7 XBT on exchange B for a cost of $3,500
  6. Simultaneously sell 7 XBT on exchange A and receive $3,500
  7. Exchange A now contains $5,140
  8. Exchange B now contains 7 XBT
  9. Wait for the spread between A and B to widen again and repeat

The above trade has generated $140 in gross profit. USD deposit and exchange trading fees must be deducted. The result will be the net profit from this arbitrage trade. Spread trading does not require the withdrawal of USD from exchange B and subsequent deposit onto exchange A which reduces fees paid. However, traders must wait for the spread to collapse before the portfolio can be rebalanced.

The BitMEX Trading Challenge Results

Thank you to all the traders who participated in the first BitMEX Trading Challenge. There were over 350 participants but there can only be one winner.

A trader with the username JMG decidedly won the first challenge. His account balance was an impressive 553.3853 XBT, for a return on equity of over 1,000%. BitMEX has sent 5 XBT to JMG’s personal Bitcoin address. BitMEX will also donate 5 XBT to The Water Project. The Water Project helps provide clean, safe water in developing countries.

The second 0.5 XBT prize was given to a trader with the username EZK27. He finished in the top 10, and was chosen at random to receive the prize.

The BitMEX Trading Challenge II is now live. All traders have been given a fresh start with 50 fake XBT. The real launch of BitMEX is weeks away. Keep learning and trading so you can start making real Bitcoin by the end of this month.

Below are the final results of the top 50 traders:

Username Margin Balance
JMG 553.3853 XBT
Fokchi123 237.2251 XBT
ppw22 172.5015 XBT
EZK27 142.9241 XBT
faeynheart 117.4818 XBT
joshlim 110.1306 XBT
NaskiaUtamu 106.9839 XBT
Username 106.3250 XBT
floopfloop 88.7515 XBT
binaryfin 74.5933 XBT
fisher 72.3535 XBT
MelonaD 69.6251 XBT
Bountoh 69.3479 XBT
medimatrix 67.5764 XBT
TrevinHofmann 65.3933 XBT
panislepickova 64.4395 XBT
apg 64.4217 XBT
facetedsubset 63.6886 XBT
antony 62.7164 XBT
shuckc 62.5893 XBT
mavoik 61.6366 XBT
alex1337 60.7224 XBT
MrSegfault 60.4425 XBT
Indeed 60.4272 XBT
Eff 60.0172 XBT
Yolos 58.1880 XBT
dashwoo 58.0261 XBT
mystisking 57.3277 XBT
darandull 57.1099 XBT
Davidjnamdar 56.2313 XBT
bos 55.5255 XBT
Merchant 55.2945 XBT
lordsonkit 54.1511 XBT
gigi 53.9036 XBT
Rizky 53.5595 XBT
fruitdealer 53.5230 XBT
ccrock 53.1972 XBT
Bkcoins 52.5674 XBT
rhk 52.4286 XBT
frederich 52.2450 XBT
mandi 51.7320 XBT
thegreatscott 51.4665 XBT
vnct 51.4356 XBT
sinedolo 51.2265 XBT
jm12 50.8369 XBT
BitInvest 50.7542 XBT
TheGlobe 50.7385 XBT
sixthsense 50.6588 XBT
pipor 50.6442 XBT
coffeens 50.6216 XBT

Bitcoin and Interest Rates

Understanding the interplay between USD and Bitcoin interest rates is critical to understanding the spot and derivatives market structure. The difference between where you can borrow and lend unsecured USD vs. unsecured Bitcoin can tell you many valuable things as a trader. The rest of this post will explore how interest rates affect the price of spot and derivatives.

Using borrowed money to buy an asset is the bedrock of finance, and is no different with Bitcoin. A trader who is very bullish Bitcoin, would borrow USD, sell USD, then buy Bitcoin. Traders who expect the price of Bitcoin to appreciate more in percentage terms than what they are paying on the USD loan. The second scenario is borrowing Bitcoin to sell it short on the market. The short seller hopes that Bitcoin will fall by a greater percentage than the interest rate on their loan. The differential between USD and Bitcoin interest rates tells traders about whether the market thinks Bitcoin will appreciate or depreciate in the future.

Besides observing USD and Bitcoin interest rates separately, the premium or discount a futures contract trades at signals whether USD or Bitcoin interest rates are higher. For Bitcoin/USD futures contracts, if the future is more expensive than spot it means that USD interest rates are higher than Bitcoin ones. Conversely if the Bitcoin/USD futures contract is cheaper than spot, it means that Bitcoin interest rates are greater than USD ones.

Covered interest rate parity describes the relationship between a futures contract, the spot exchange rate and the interest rates of the home and foreign currency.

F = S * (1 + R_f) / (1 + R_h)

F = Future price; S = Spot; R_f = Foreign currency interest rate; R_h = Home currency interest rate

A simple example will illustrate how this process works. Jane is a foreign exchange trader. The spot price of Bitcoin is $100, while a futures contract expiring in one month has a price of $200. Jane knows she can borrow money from the bank at 100% per month interest. Jane’s friend James is looking to borrow Bitcoin to sell it short. He is willing to pay 25% per month in interest. Jane’s other friend Jack wants to sell Bitcoin in one month’s time for $200 per Bitcoin. Jane sees an arbitrage, if she borrows USD from the bank, buys spot Bitcoin, lends her Bitcoin to James, and then sells it forward to Jack, when the futures contract expires she stands to make $50.

Jane goes to her local bank and takes out a loan for $100. The bank charges her 100% to borrow the money for one month. Jane must pay the bank back $200 in one month’s time. She takes the $100 and buys 1 Bitcoin. James borrows Jane’s 1 Bitcoin and will pay her back 1.25 Bitcoin at the end of the month. Jane promises Jack that she will deliver 1.25 Bitcoin in one month’s time for $250.

After one month, Jane gets her 1.25 Bitcoin back from James. Jane then delivers 1.25 Bitcoin to Jack and receives $250. Jane then pays back her bank loan of $200; the $50 left over is profit.

Plugging in the numbers to the formula, Jane’s arbitrage opportunity becomes obvious.

$100 * (1 + 100%) / (1 + 25%) = $160

If Jane can sell Bitcoin forward at a greater rate than $160, she can make a risk free profit. Are there arbitrage opportunities in Bitcoin like the one presented above? Of course. The USD rate at which speculators are willing to borrow at and margin trade is much higher than the Bitcoin borrow rate short sellers pay. The market believes Bitcoin will appreciate in the future and speculators are willing to pay a high interest rate to leverage their positions.

For the lucky traders who can borrow USD below the rate speculators are paying on margin trading platforms, can make easy risk free profits. Arbitrageurs give up the potential massive upside in Bitcoin’s value for steady non-volatile profits.

Thoughts On China’s “Ban” On Bitcoin

When the dust settles and all the banks and payment processors are in compliance we expect the Bitcoin price to fall to the recent lows of $360 and BTCCNY to be at a 5%-10% discount to BTCUSD. Then buy your coins back at a discount, transfer to an exchange where you can withdraw USD and collect a nice profit.

Last week Caixin posted an article claiming that the PBOC was not satisfied with how banks and third-party payment processors were interpreting it’s ban on financial institutions processing payments related to Bitcoin based businesses. Subsequently a few exchanges announced that their bank accounts at certain onshore Chinese banks were shut. The Bitcoin price fell around 12% after the announcement and then further to around $425 on Bitstamp. The price on the leading Chinese exchanges traded at around a 3-5% discount to Bitstamp.

Fast-forward to today on the eve of the Labour Day weekend holiday and the Bitcoin price has recovered around $25 to $450 and the Chinese exchanges are trading slightly more expensive than Bitstamp. Even after all of this noise from the PBOC you can still fund  your Bitcoin account with CNY at certain exchanges using Bank of China. How this is possible when the PBOC has repeatedly said that financial institutions cannot process Bitcoin based payments is very puzzling.

The Caixin article postulates that the new “deadline” for compliance is May 10th. We at BitMEX are in the business of facilitating betting men and women. If we were in your shoes, we would be opening accounts at the leading Chinese Bitcoin exchanges such as OKCoin and BTCChina and buying coins on Bitstamp transferring them to a Chinese exchange and selling Bitcoin for CNY. A four day bank holiday is the perfect time to force compliance with the central bank’s directive. When the dust settles and all the banks and payment processors are in compliance we expect the Bitcoin price to fall to the recent lows of $360 and BTCCNY to be at a 5%-10% discount to BTCUSD. Then buy your coins back at a discount, transfer to an exchange where you can withdraw USD and collect a nice profit.

Good luck, and happy trading!

CEO Arthur Hayes To Speak On Bitcoin Derivatives At Inside Bitcoins Hong Kong

BitMEX CEO Arthur Hayes will be speaking on the 25th of June from 3:00 PM to 3:45 PM on Bitcoin derivatives and the current market structure.

BitMEX CEO Arthur Hayes will be speaking on the 25th of June from 3:00 PM to 3:45 PM on Bitcoin derivatives and the current market structure.

Bitcoin Derivatives: What Are They? And Why We Need Them

While trading volumes on spot exchanges have risen dramatically since early 2013, the derivative market remains nascent and grossly underdeveloped. Many high profile figures in the Bitcoin community have been calling for a liquid derivatives market. This panel will examine what is meant by a Bitcoin derivative, the different uses of derivatives by different market participants, and the benefits to having a liquid and robust market. We will examine the current landscape of derivatives products and help attendees grasp the different uses and risks with trading different types of derivatives. We will also look to the established market of fiat currency derivatives to gauge what sort of market growth is needed to develop a healthy ecosystem.

Inside Bitcoins Hong Kong