Crypto Trader Digest – Sep 7

Brokedown Palace: EM FX

BROKEDOWN PALACE, seated front from left: Claire Danes, Bahni Turpin, 1999, TM & Copyright © 20th Century Fox Film Corp.

 

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:

  1. Buy Bitcoin, sell USD at one of the big global exchanges.
  2. Sell Bitcoin at a premium, buy your local EM currency. You now have EM currency that you need to convert back into USD.
  3. 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.
  4. 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)

xi-jinping

 

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

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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

Screen Shot 2015-09-07 at 5.22.47 pm

 

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.

Crypto Trader Digest – August 10

Bye Bye, New York State

nyc

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

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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:

  1. Each ETH7D contract represents 1 Ether (ETH). The contract references the Kraken ETHXBT exchange rate and profit and loss are denominated in Bitcoin.
  2. 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.
  3. If ETH7D trades at 0.0025, you have locked in a profit of (0.0025 – 0.0005) * 10,000 = 20 XBT.
  4. 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

china-ghost-town

 

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

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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

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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

Screen Shot 2015-08-10 at 6.45.10 pm

 

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.