The Future of Bitcoin Trading

The days of Mt. Gox are long behind us, and with the slaying of the giant, there was plenty of room for competitors to fill the void and spread the wealth. The scope is brought home when you see the Global Price Index by BraveNewCoin is being comprised from 60 of the world’s most liquid Bitcoin exchanges.

It did not take long for the experienced financial talent to capitalize on the trading frenzy and in 2014 the race was on to build the perfect leverage trading platform since the most volatile asset in the world was clearly not enough for the Bitcoin believers.

While more traditional exchanges like Bitfinex and BTCe added some leverage in the 3x area along with the ability to enter short positions, startups like took it all the way to 10 times leverage even though they were still subject to the traditional forces of executing direct trades on other exchanges.

Futures & Socialized Loss

This brought us to the next phase of trading where the concept of Futures was first implemented within the Bitcoin space. The movement started with the Chinese exchange 796 offering positions with up to 20 times leverage. Like a traditional future, it was just as easy to go long or short with all the volume being handled without actually hitting the Blockchain.

However, the problem that had to be resolved first was Counterparty Risk and the idea of “Profitable Accounts Socialized Loss” was born. This idea has now been adopted across other Futures Exchanges like OKCoin and BitVC is definitely an interesting solution to the problem.

If traders were not aware of how it works, they found out this week as the winners were taxed to cover the losses suffered by the exchanges during margin calls of positions that went bust. By only needing to put 5% on margin, the days that Bitcoin moves over 10% can be devastating. The outcomes of socializations to profits were: BitVC (Huobi) - 46.1%, 796 - 25.01%, OKCoin - 5.15% on their Futures contracts expiring at the end of last week.

While there are advantages to these exchanges, like only putting up 5% of your bitcoins to be under control by a third party and also being able to open an account in minutes without any hassle, the possibility of having to give up some profits should also be taken into consideration; especially when the object of the game is spread trading, arbitrage or hedging your current position at more traditional exchanges.

Of course, as volume on these exchanges increases and the expectation of Bitcoin’s volatility comes down over time, these socialized losses should not spike to these levels. In the mean time, a slightly different Bitcoin Exchange is entering the playing field with a focus on Risk Management.

Enter BitMEX

Scheduled for live trading as of November 24th, BitMEX intends to be the first Futures Exchange that does not subject profitable accounts to socialized losses. Of course no reasonable Risk Management focused exchange would be able to offer 20 times leverage or the same cheap commissions as the 3 mentioned above, but this is the beauty of this exciting new frontier: there is always an alternative around the corner and plenty of room for all to grow and compete.

“BitMEX centrally clears all its derivative products,” said BitMEX Co-Founder and CEO, Arthur Hayes. “On a centrally cleared exchange, the exchange faces both buyer and seller as the central counterparty. In the event that one side goes bust, the exchange steps in and makes good on its obligations.” He further explained in a recent newsletter:

“BitMEX will be the only Bitcoin derivatives exchange offering this protection. Because BitMEX is the only exchange offering this, it is the only derivatives exchange where one can truly hedge. Our number one focus is risk management because we have skin in the game. As a result, the amount of leverage offered on our products is lower and the attention paid to margin policy is heightened. For example, instead of liquidating entire positions using market orders, during a margin call we incrementally liquidate positions. Liquidation stops once a trader's equity has recovered to the mandated level. Traders can live to fight another day instead of being completely wiped out from a temporary dip or peak.”

“Our Chief Risk Officer (CRO) is responsible for determining the amount of leverage offered and implementing margin policy. Using Standardized Portfolio Analysis of Risk (SPAN) scenario analysis, the CRO changes different pricing inputs to determine possible losses to traders' portfolios and adjusts the exchange's margin policy accordingly.”

“When the price of Bitcoin can go from US$380 to US475 and back to US$380 in 24 hours, counterparty risk becomes non-trivial. Choose your exchange wisely, and make sure you understand completely how the exchange conducts its margin policy." 

So what is next for this space? We will see, but most likely, traditional Options contracts will be developed soon and perhaps an exchange with a clearinghouse and a liquidity pool accessed by other exchanges. Only time will tell, but it sure is exiting to watch as it all goes down at incredible speed in comparison to traditional fiat financial markets.

Disclaimer: Tone Vays will be speaking on the same panel as Arthur Hayes at the upcoming Bitcoin South conference in New Zealand.

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