Hi all!
Today the curtain went up on Invest: NYC, our event focused on institutional investment in crypto assets. If you’re here, you’ll be able to hear from a wide range of experts on markets, crypto assets and how they fit into the broader macro context. You can check out our agenda here – keep an eye out for related stories on coindesk.com, and videos of the main stage sessions will be available soon.
Readers of this newsletter will have noticed the growing role of derivatives in the crypto conversation. In THE BRIEFING, Emmanuel Goh of skew.com shares his vision of where crypto derivative markets are heading, and what that means for the sector overall.
And below, as usual, you'll find selected links to keep you up to date with the ideas and developments that are shaping the evolution of this fascinating segment of finance – the underlying shifts are much deeper than most of us realize.
Read on…
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Emmanuel Goh is co-founder & CEO of skew., a financial technology startup backed by leading venture funds which recently launched skewAnalytics, an analytics product for crypto derivatives markets. These opinions are the author's own and do not reflect the view of CoinDesk.
Crypto derivatives: A corner of the market or the market itself?
The race is on. One business day before the much-awaited ICE / Bakkt launch, the CME announced it would be listing Bitcoin options in Q1 2020. ICE returned the favor by announcing it would also be launching options contracts but in December this year!
Why are two of the largest exchanges in the world competing so openly for a space that was considered, until recently, as secondary by most industry insiders?
Trending
Almost every week, a new player is announcing its intention to enter the increasingly crowded crypto futures market. Most recently crypto behemoths Binance and Bitfinex launched their own futures products, with varying degrees of success.
This optimism wasn’t always there. The rise of Hong-Kong based BitMEX – home to the most liquid bitcoin contract globally – was for a long time met with skepticism by industry leaders, who dismissed the product as only serving gambling addicts with the use of high leverage.
The crypto futures market really took off in 2018. Volumes increased by a factor of ten compared to 2017 levels – a year widely seen as the peak of the crypto market. Bitcoin futures and other perpetual swap instruments are now trading, on average, 10x more volume than the underlying bitcoin spot market according to data compiled by skew and Bitwise .
(source: skew.com)
In hindsight, it is relatively simple to explain why. As the market entered a prolonged downturn starting in 2018, market participants looked for ways to profit from, or at least hedge against, the falling prices. The growth in futures markets came from that need to short the market.
The market evolved rapidly from very little two years ago. In Q4 2017, the Financial Times published, in a well-researched article, how shorting the stock of chipmaker Nvidia – the products of which were very popular with cryptocurrency miners - could be one of the most convenient ways to get short exposure to cryptocurrencies!
A crypto anomaly? Not really...
Traditional markets also experienced a “derivatives moment” in response to increased volatility in the market. The seventies were a period of incredible financial turbulence as Richard Nixon abolished the Bretton Woods system in 1971, moving to a fiat monetary system, and allowing all currencies to float. The world subsequently went through the first oil shock in October 1973, sending the price of black gold skyrocketing in what was previously a quiet market.
A few months prior, in 1973, in a (not so) curious twist of events, Fischer Black and Myron Scholes found a simple analytical formula to price options, which won the 1997 Nobel Prize two decades later. The conjunction of those two events is widely seen as having started a glory period in derivatives products across all asset classes.
It wasn’t just a fad. The DC-based Office of the Comptroller of the Currency estimates banks currently have exposure to more than $200 trillion notional of derivatives. Derivatives have gradually become the place where the majority of interested parties are coming to trade – across all markets.
“We will tame Bitcoin” – Emeritus CME chairman Leo Melamed
Should we believe the prediction from the legendary futures trader?
There has been a consensus view that bitcoin is too volatile to be a medium of exchange – triggering a wave of “stable coin” projects in 2017 and 2018. The inelastic supply function of bitcoin is, by construction, indifferent to demand or supply shocks – making all the adjustment occurring through price and creating volatility as a result. Good logic, but not necessarily true in practice! For instance, this argument is also valid for gold, which is one of the lowest volatility assets around, with an average daily move of 0.6% in 2019 according to data obtained from the Federal Reserve of Saint Louis.
There are a number of factors that contribute to an asset’s volatility. One of them is its market structure. Academics have extensively researched the impact of developing derivatives markets on the volatility of underlying assets and have overwhelmingly concluded that derivatives help to stabilize prices.
This is particularly true for options, as flows are usually dominated by call overwriting (selling calls to overlay an underlying position) as investors are looking to generate extra yield. The income fund launched by LA-based Wave Financial is a first step in that direction within the crypto markets.
Bitcoin’s volatility will decrease structurally as those markets keep growing.
Natural selection
Derivatives rhyme with leverage, which essentially allows you to do more with less. That’s great, but only to a certain extent. As Warren Buffet famously said, derivatives are financial weapons of mass destruction and require careful risk management.
Regulators have as a result been working on curbing the use of leverage globally. In May 2019, Japan’s FSA asked bitFlyer to reduce leverage for its perpetual swap product. The UK FCA is taking even more drastic action by planning to ban the offering of crypto derivatives to retail investors. The regulator also asks retail brokers to warn their customers of the risks of investing using derivatives products, across all asset classes.
“CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. 72% of retail investor accounts lose money when trading CFDs with this provider.” – Welcome message on a popular retail brokerage platform
If 72% of investors lose money trading CFDs on low volatility underlyings, what could go wrong trading 100x levered products on the infamously volatile bitcoin?
It is likely that, over time, regulators or simply Darwinism will increasingly put the derivatives market in the hands of professionals.
Not only about volumes
Most participants – including us at skew. – spend probably too much time worrying about volumes. Derivatives volumes are mostly a function of leverage. When Japan’s FSA asked bitFlyer to reduce the maximum available leverage from 15x to 4x on the 28th of May, its volumes declined overnight by at least 50%.
(source: skew.com)
Derivatives are zero sum contracts between two counterparties. Traders and investors have to maintain collateral against those open positions. Leading venue BitMEX asks for a minimum maintenance margin of 0.5% and a minimum initial margin of 1%. The CME on the other hand asks for 37% of initial margin. That means if you would like to open a $1 million long position on BitMEX, you can post as little as $10,000 in collateral versus at least $370,000 at CME.
The total $ amount of bitcoin futures contracts opened – called open interest – at CME currently stands at $150 million contract in comparison with $1.1 billion at BitMEX. Because of margin requirements it is likely there is a similar amount of money “working” to trade Bitcoin derivatives at CME and BitMEX despite the later trading 10x more volumes. The “herd” might be closer than people think.
This is a great setup for the offshore exchanges which are able to make significantly more money from the same amount of capital as they collect their fees from the volumes traded.
An increasingly central question: what is the price of bitcoin?
Victims of their own success, derivatives venues were hit in 2019 with a first-world problem.
As trading occurs on margin, derivatives exchanges have been careful to design a spot price index derived from the price of what were, initially, much larger physical exchanges. The index is used to settle the contracts at expiry, and decide when to initiate margin calls. It was a smart way of preventing manipulation of the then not-so-liquid crypto derivatives contracts.
However, as the derivatives market has grown exponentially, we have now entered a period where the underlying physical exchanges are much smaller than the derivatives exchanges – only 10% of total volumes in aggregate. It has become tempting to try to manipulate the less liquid underlying exchanges to yield some profits trading the derivatives.
This was most visible earlier this year in May when a relatively small-size order on physical exchange Bitstamp triggered a wave of liquidations at BitMEX and took the entire market down.
Exchanges seem to have been increasingly aware of the problem and have been attempting to strengthen their indices – sometimes with unfortunate consequences, as with a recent miscalculation at Deribit costing the exchange $1.3 million.
“There’s a whole ocean of oil under our feet! No one can get at it except for me!” – There Will be Blood’s Daniel Plainview
With the CBOE officially out, expect the competition between CME and ICE to be heating up in 2020 as the two exchanges roll out their options offering.
It would be particularly encouraging to see corporate hedging flows taking off, led by mining companies and supported by physically delivered and options contracts. The Mexican government is said to have spent $1 billion premium in put options this year to hedge its 2020 oil production. Still some way to go for crypto derivatives!
– Emmanuel Goh
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* it's a really busy week for everyone, so here's six entries that are especially relevant - but be sure to take a look at the rest when you can!
BIG IDEAS
*Bitcoin Cannot be Banned (Unchained Capital) – Bitcoin will only be worth banning if it is successful, whereupon it will be even harder to ban.
*The Bitcoin Reformation (Adamant Capital) – Four conditions present at the dawn of the Protestant Reformation are also present today, and could presage as grand a shift: a painful status quo in the form of a monopoly service provider, technological catalysts, a new economic class, and the defendability of ideas.
*Alex Kruger kicked off a “bitcoin as sound money” debate, pointing out that most people just don’t care.
Willy Woo classifies altcoins into Oscillators and Degenerators, and explains the important difference.
Why Bitcoin’s Next ‘Halving’ May Not Pump the Price Like Last Time (CoinDesk) – It’s not just about the model; it’s also about the narrative.
A Clear Vision for Digital Assets – 3 Predictions for DLT in 2020 (TabbFORUM) – John Liu of Fusion highlights three areas of development that will have the greatest short-term impact on digital asset adoption: blockchain interoperability, decentralized custody and stablecoins
Thinking like a Crypto Quant: Multi-Factor Strategies for Crypto-Assets (IntoTheBlock) – The tradeoffs between one vs. many factors on single or multiple asset portfolios.
Chris Espley introduces the concept of “generativity” to explain crypto’s resilience and potential growth.
Crypto is Modern Alchemy (Meltem Demirors) – The crypto sector needs to move away from its pseudo-science culture, with fiercely held ideas, rejection of criticism and a blind belief in a utopian future, towards proto-science, with evidence, dialogue and adaptation.
MARKETS
Crypto exchanges experiencing a steady drop in traffic since June, suggesting declining retail interest (The Block, paywall) – An analysis of 37 exchanges revealed a 37% decline in traffic since the end of Q2.
Exchange volumes suggest decreased interest from Asian investors (The Block, paywall) – Analysis shows lower volumes since June in all markets, especially with Asian exchanges.
One Tether Trader Didn't Cause the Bitcoin Bubble (Bloomberg, paywall) – Unpacking blockchain data is complicated.
The Art of Following Triggers: Discipline in Trading (Xena Exchange) – Crypto day trading is intense; emotional and technical discipline is essential.
Uncover the Mystery of Bitcoin Whales: SFOX Interviews Whale Alert (SFOX) – How large holders influence the bitcoin market.
Crypto Market manipulation lawsuit against FTX Trading seeking $150M contains more words than substance (The Block, paywall) – A skeptical take on the recent lawsuit presented in California against FTX Trading.
3 Insights on Crypto Derivatives and Risk From Veteran OTC Traders (CoinDesk) – If you missed our webinar on crypto trading, we summarize three of the main insights: there’s more “velocity” these days as more traders (vs long-term investors) come into the market; derivatives are increasingly influencing the spot market; and the derivatives sector is dominated by two products, perpetuals and futures.
First-Time Bitcoin Buyers ‘Doubled’ in Square’s Q3 Report (CoinDesk) – Square processed $148 million in bitcoin sales in the third quarter of 2019, over three times that of the same period last year.
Pension Funds Double Crypto Asset Exposure in Morgan Creek’s Fund to 1% (CoinDesk) – Two of the three Fairfax County pension funds that invested earlier this year have made further investments in the asset manager’s second fund.
WATCH: What Are the Main Takeaways From Deribit’s $1.3 Million Flash-Crash? (CoinDesk, video) – A chat with Yan Lieberman of Delphi Digital on the cause of and reaction to the recent flash crash, and the outlook for bitcoin.
NEW PRODUCTS
Crypto-Friendly Silvergate Bank Goes Public on New York Stock Exchange (CoinDesk) – The initial price was $12 per share; the updated prospectus revealed that the bank currently serves over 750 crypto-related firms, up from 542 reported in March.
Tassat Is One Step Closer to Offering Crypto Derivatives With CFTC Approval (CoinDesk) – The firm formerly known as trueDigital Holdings has received approval from the CFTC to take over the SEF registration from trueEX, which puts it closer to its goal of offering physically delivered bitcoin swaps and other products.
Coinbase Will Now Reward Users for Holding This Cryptocurrency (CoinDesk) – The crypto exchange is for the first time allowing general users (except for residents of Hawaii and New York) to earn an estimated 5% annual return by simply holding the Tezos token.
The SEC Has Rejected Every Bitcoin ETF. This Firm Thinks It Has a Solution (CoinDesk) – The SEC is currently reviewing an application filed in May by Wilshire Phoenix and NYSE Arca, for an ETF that would invest in both bitcoin and U.S. Treasury securities.
PROFILES
Inside Jump Trading: The little-known crypto kingmaker working with the world's most prominent cryptocurrency firms, and trading millions (The Block, paywall) – One of the largest traders on BitMEX, the firm has also begun market making for cryptocurrency projects and is planning a push into the Asian crypto markets.
What it means to own your data in USV co-founder Brad Burnham’s brave new world (The Block) – The investment thesis and approach of Placeholder Ventures, and how the value of personal data could be leveraged while remaining sovereign.
Binance is Blitzscaling (Multicoin Capital) – How a crypto-first company uses an aggressive growth strategy to dominate the emerging neo-banking market.
Catherine Coley’s quest to conquer crypto (Decrypt) – Binance.US’s CEO shares her vision for broad cryptocurrency adoption.
Asia’s Bakkt? AAX Rolls Out Crypto Trading With London Stock Exchange Tech (CoinDesk) – The crypto exchange, the first to use the LSE’s low-latency Millennium Exchange matching engine, targets retail and institutional investors with spot, futures and OTC trading.
WATCH: Binance CEO CZ Says Crypto Exchange Is No ‘Outlaw’ (CoinDesk, video) – A four-part interview that hints at significant announcements ahead about the crypto exchange’s presence in Russia, and the growing role of stablecoins.
CRUNCHING NUMBERS
Crypto and Blockchain Jobs Have Increased By 26% Since 2018: Research (CoinDesk) – The number of people looking for work in the sector has plummeted, however.
Delphi Digital’s latest BTC Outlook report looks at the relationship between open interest on the derivatives market, and the bitcoin price.
On Bitcoin’s Convergence: Simplified, Part 1 (AJC) – Bitcoin’s market cap appears to be converging towards the stock-to-flow model, which predicts a “halving window” price of $14,000-$20,000 in May 2020.
REGULATORS AT WORK
US Congress Weighs Bill Spelling Out CFTC’s Crypto Derivatives Oversight (CoinDesk) – A provision in the 2019 CFTC Reauthorization Act clarifies how the regulator would collect information on digital commodities contracts and commodity swaps.
Global Crypto Framework Needed to Stop ‘Regulatory Arbitrage,’ Watchdog Warns (CoinDesk) – The CEO of Hong Kong’s securities regulator, Ashley Alder, worries that global initiatives such as Libra pose a threat to a coordinated response to money laundering and financial crime.
Binance to Advise Ukraine Government on Upcoming Crypto Regulation (CoinDesk) – Ukraine’s Ministry of Digital Transformation has signed a memorandum of understanding with Binance to work together on “establishing the potential legal status of virtual assets and currencies in the country.”
Hong Kong Regulator to Treat Some Crypto Exchanges Like Brokers (CoinDesk) – The Securities and Futures Commission has announced a new licensing scheme for virtual asset platforms that is similar to the one applied to security brokers and automated trading venues.
Only 1 Crypto Fund Has Passed Hong Kong’s SFC Regulatory Hurdles in First Year (CoinDesk) – According to Reuters, that fund is Diginex; many other funds are moving out of Hong Kong to get around the rules, or are applying without intention of complying.
SECURITY TOKENS
Leading Japanese Firms Partner on Security Token Research (CoinDesk) – Mitsubishi UFJ Financial Group, one of the world’s largest banks, is leading a 22-member research consortium to develop standards around security token management.
Security tokens are still the Next Big Thing, and industry players say they're poised for huge growth in 2020 (The Block, paywall) – The crypto winter and lack of regulatory clarity contributed to a waning of interest in late 2018, but it appears to be coming back, largely driven by institutions.
STABLECOINS
*Stablecoins: Popularized by Facebook, Pilloried by Regulators (Bloomberg, paywall) – Gregory Klumov, founder and chief executive officer of Stasis, outlines the impact stablecoins could have on global trade.
Coinbase Legal Chief Says Private Sector Should Build US Digital Dollar (CoinDesk) – Brian Brooks argued, in an essay in _Fortune_, that private corporations are best positioned to build a much-debated digital U.S. dollar, and that the government should stand back and let them.
European Union to Regulate Stablecoins, Not Issue Its Own: Source (CoinDesk) – Media reports had erroneously suggested that the European Union was considering the issue of a central bank-backed stablecoin.
Tether Says Its Stablecoin Is ‘Fully Backed’ Again (CoinDesk) – In a response to a paper alleging that the stablecoin was used to manipulate bitcoin prices in 2017, the issuer confirmed that its stablecoin was now 100% backed by fiat reserves.
USDC Stablecoin Surpasses Another DeFi Milestone: $50m Borrowed for Loans (Coinbase) – According to data from Loan Scan, about 1 in 10 loans originated on Compound, Dharma and dYdX was denominated in USDC.
PODCASTS
BITCOIN MACRO: Our Nolan Bauerle talks to Josh Brown, CEO of Ritholtz Asset Management, on how bitcoin is not yet a macro asset, its narrative as a protest asset is not yet borne out by the figures, and its potential will take longer to realize than we expect (and that’s ok).
BITCOIN MACRO: Nolan also chats to Meltem Demirors of CoinShares about narrative bias, the novelty of choice when it comes to money and how speculation is a gateway to deeper engagement with crypto assets.
BITCOIN MACRO: And Nolan also interviews Ambre Soubiran, CEO of Kaiko, about bitcoin’s intrinsic value, it’s potential role as a safe haven and how hard it is to define.
FLIPPENING: In a flipping of the Flippening, Clay Collins of Nomics is interviewed by Rob Paone of the Crypto Bobby Podcast about exchange data, what ticket stuffing is and how wash trading can hurt investors.
*WHAT BITCOIN DID: Peter McCormack chats to Bloomberg’s Joe Weisenthal about bitcoin in a macro context, what could kill it, what bitcoiners get wrong about money and how often technology evolves away from its original intent.
STATE OF CRYPTO: The Amun team talk to Stephen McKeon, partner at Collaborative Fund, about the emergence of digital commodities and the markets that are emerging around them, barriers in the way of adoption and the importance of analytics platforms.
BLOCK CRUNCH: Jason Choi chats to Ryan Sean Adams of Mythos Capital about ethereum’s changing investment thesis, the threat to the network from competitors, and potential upcoming changes to the underlying protocol.
A-HA!
*The World Has Gone Mad and the System Is Broken (Ray Dalio) – Excess money chasing negative or low yields, looming public funding requirements that are unlikely to be met, and deficits that will most likely be fed by printing more money, are further pushing the can down the road towards a paradigm shift.
MASTERS IN BUSINESS (podcast): Barry Ritholtz talks to Eugene Fama and David Booth on how Wall Street research is “business-based pornography,” behavioral finance doesn’t really exist, people see bubbles where there are none, and the best indicator of fund performance is not past performance but fees.
OK Kids. This Boomer Has Had Enough. (Bloomberg, paywall) – Tyler Cowen on how surely the millennial or Z generation can do better in terms of rebellion than “Ok, boomer.”
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FIRMS
Crypto exchange Coinbase has reduced the confirmation requirements for deposit finality for bitcoin, ethereum classic and zcash, and increased those for litecoin.
Security token platform TokenSoft has launched support for registered Investment Companies under the 1940 Act including ’40 Act Funds.
U.K.-based cryptocurrency exchange CEX.io has joined the Silvergate Exchange Network, the payment rail connecting major customers of crypto bank Silvergate, such as Coinbase Prime, Cumberland, Kraken OTC, BitStamp, Jump and Circle, to name a few.
PEOPLE
Blockchain analysis platform Chainalysis has appointed Jason Bonds (previously at Ping Identity) as Chief Revenue Officer, Chris Manouse as Vice President of Public Sector, and Debra Brown as Vice President of Americas.
Have a tip? Drop me a line at [email protected]. |
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