Using Derivatives To Reduce Counterparty Risk

Why did Bitfinex hold over 200,000 XBT prior to being hacked? For people who want to buy and hold Bitcoin, they should never leave their funds on an exchange.

Ideally, the duration of counterparty risk exposure for simple buy and hold trades should be a few hours. Once a fiat deposit has been credited, buying Bitcoin or another digital asset takes minutes. After you receive Bitcoin, you should withdraw it.

Bitfinex and other spot exchanges hold so much Bitcoin because most of their users are casual or heavy speculators.

If you want to speculate in Bitcoin or other digital assets without exposing 100% of your capital to counterparty risk, using derivatives is prudent. Derivatives do not require physical settlement of any asset, rather they are bilateral contracts enforced by the exchange.

Because there is no physical settlement like margin trading, the leverage offered can be much higher. BitMEX offers leverage of up to 100x.

Assume you have 100 XBT of capital. You wish to speculate on the future price of Bitcoin. The BitMEX Bitcoin / USD swap product, XBTUSD, features 50x leverage. This means that with only 2 XBT deposited on BitMEX you can trade the full amount of your 100 XBT capital. If you’re willing to trade with such leverage, 98 XBT can be held safely in cold storage. More realistically, given price swings, we would recommend holding at least 10% (10 XBT) equity. Contrast that with Bitfinex where 33 XBT would be required to trade a 100 XBT position.

BitMEX allows you to keep the majority of your personal Bitcoin in cold storage, but still trade large positions. And, of course, the Bitcoins on BitMEX are also kept in cold storage.