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Crypto Trader Digest

January 12, 2014
Arthur Hayes
Co-Founder & CEO

BitMEX Bitcoin Historical Volatility Futures Contract

BitMEX rang in the New Year by launching the world’s first Bitcoin historical volatility futures contract. The BitMEX 30 Day Historical Volatility Futures Contract (BVOL) allows investors to trade Bitcoin / USD realised volatility using prices observed on Bitfinex. The product began trading 5 January 2015. For every 1% point increase in the annualized historic volatility investors stand to gain or lose 0.01 Bitcoin. BVOLG15 is the current volatility future that is available for trading, and the only way to trade volatility on any Bitcoin exchange.

To learn more about the product and how it may be used in your portfolio, read the BitMEX blog post “Bitcoin Volatility As An Asset Class”. 

Got Stamp'd? How BitMEX Approaches Security



The Bitstamp melodrama surrounding the hack of almost 19,000 Bitcoins has come to an end. Hackers were able to siphon off Bitcoins from Bitstamp’s hot wallet. In Bitcoin speak, a hot wallet is a Bitcoin address where private keys are kept on an internet connected server. Exchanges use hot wallets to quickly process customer withdrawal requests. A majority of customer funds are usually held in a cold wallet where the private keys are stored offline. However, as the Bitstamp case demonstrates, Bitcoin exchange hot wallets are a scrumptious target for nefarious actors. For that reason, they generally should be kept as small as reasonably possible. Thankfully, Bitstamp made all customers whole and was able to resume trading in under a week.

Security is a hot button issue, and I want to take the time to discuss how BitMEX secures customer funds. When depositing Bitcoin to your BitMEX account, you will notice that the address begins with “3”. The “3” means that the address is the hash of a script (in this case, a multi-signature script). BitMEX uses multisig for each and every address. The keys are held offline, independently by the co-founders. To spend any funds from an address, a majority of partners must sign a transaction. Because all funds are held in multi-signature addresses, there are no private keys on any internet exposed server and all withdrawal transactions must be manually processed.  This ensures that even if BitMEX systems were fully compromised, customer funds could not be stolen.

In addition to securing customer funds, BitMEX conducts real-time reconciliation of customer deposits and derivative positions. This is similar to how a bank does reconciliation at the end of the day, but the process runs continuously on BitMEX. A derivatives exchange is a sum zero environment. Someone’s gain is someone else’s loss. If this basic accounting identity is ever false, trading halts immediately and BitMEX directors are notified. The engine also continuously monitors the balance of all deposit addresses. If the blockchain record does not match with internal BitMEX records, trading halts immediately. Small inconsistencies are not allowed to fester and grow and lead to possibly to the default of the entire exchange. This gives our customers confidence that if BitMEX is open and handling trades, it is functioning as expected and funds are secure and accounted for. The security of customer funds is our number one concern and it is reflected through our business practices.

XBT Spot



The Bearwhale is now gloating over the carcasses of slain traders. The ball dropped and Bitcoin plummeted. From $322 on New Year’s Day to $255 in less than one week, Bitcoin has begun 2015 by eviscerating many traders’ portfolios. The Bitstamp heist happened only days after the plunge. As the price recovered during the first week of the year, traders anticipated the resumption of Bitstamp operations and a subsequent spike above $300. I was one of those traders, and I was flat out wrong. On 9 January 2015, Bitstamp reopened and the price rose to $297 but couldn’t crack $300. This ride is not over, and lower lows seem increasingly likely.

Where is the bottom? I have learned over my trading career it is futile to attempt to call a bottom or top. However, I believe the next resistance levels are $250 and $200. The $250-$260 range coincides with the April 2013 highs. A decisive break below that level and we may be staring at a “1” handle. If you were hoping for a violent rebound, that hasn’t happened and it is time to move net short XBT. Accumulate short positions to prepare for a re-test of $250. If the price breaks look to cover in the low $200’s. The risk of a short squeeze is ever present. Monitoring the level of short swaps on Bitfinex is a must. A successfully executed short squeeze could send the price screaming above $300.

Trade Recommendation:

Go short XBT with a $270 - $280 entry price using 30 January 2015 Bitcoin / USD Futures (XBTF15), looking for a decisive break below $250. Cover the short around $220 and prepare for the assault on $200.

Chart: Cryptowatch

XBTUSD Basis Term Structure



Leveraged margin trading is popular with traders especially those who wish to short sell Bitcoin. The recent price plunge has pushed XBT swap rates above USD ones on Bitfinex. The bad facet of shorting any asset is that the price can only go to 0. At most you can earn 100% whereas upside returns are infinite. Traders wishing to take a longer term view on basis should begin buying it via long dated futures contracts.

The chart above shows the hourly per annum basis between the Volume Weighted Average XBT and USD Swap Rate on Bitfinex, and the hourly Volume Weighted Average Price on Bitfinex. Swap rates are quoted in daily terms so I have chosen to annualize the basis using the following formula:

(1 + VWAR_USD * 365) / (1 + VWAR_XBT * 365) - 1

Price spikes in the basis are accompanied by comparable spikes in price. Over the past year, basis has usually been positive even as the price fell from $1,000 to $255. The decline of basis affects all maturities and long dated futures contracts are considerably cheaper in basis terms than they have been in recent memory. BitMEX offers XBU chain futures contracts with maturities out until September 2015. Buying calendar spreads eliminates spot price risk and leaves a pure play on basis. The 27 March 2015 vs. 25 September 2015 XBU calendar spread (XBUH15_U15) is the ideal candidate. The outright legs’ basis is trading at $5-10 for March and $25-$30 for September. An intra-month spread of $20 at a spot price of $270 is approximately 15% per annum basis. When Bitcoin rebounds, the curve will steepen and long basis trades will show a profit.

Trade Recommendation:

Buy XBU 27 March 2015 vs. 25 September 2015 (XBUH15_U15) calendar spreads to profit from a parallel shift upwards in the basis term structure.

Data: BFXdata

Bitcoin Valued As A Call Option



In the long term, most traders agree Bitcoin will either be worth a very large amount - or very little. The asymmetric payoff, infinity for longs vs. 100% for shorts, resembles a long dated out of the money call option. The premium is your entrance ticket and that is the current Bitcoin price. The underlying asset volatility is the most crucial factor when determining the fair price of an option contract. Bitcoin price volality in the fall / winter of 2013 was dramatically higher than where it stands today. Over the same time span the Bitcoin price has fallen almost 80%. Is the fall in volatility correlated with the fall in price?

To test the strength of the relationship I constructed a data series of Bitfinex XBTUSD 90 day moving average prices and 90 day realised volatility starting in October 2013. The graph above displays the two data series. The general trend has been downward for both price and volatility. The correlation between the two is 0.623587, which shows a relationship. Basing trades on this correlation requires a longer time horizon.

Investors with access to dealers who will make OTC option prices might be able to buy longer dated volatility. But shorting long dated Bitcoin volatility is a very dangerous game. There is unlimited downside for sellers of volatility and very few counter parties whom with to cover the short. As a result if you can find quotes on long dated volatility, they will be at a considerable premium to current realised volatility.

As mentioned above, BitMEX has launched a historic volatility future. The inaugural contract BVOLG15 expires on 27 February 2015. As interest grows in the product, BitMEX hopes to offer longer dated maturities. Then the type of trade described above will be possible with in house products.

Trade Recommendation:

Buy long dated (1 year or longer) volatility via options strategies. To profit from a short term rebound in volatility buy 27 February 2015 Bitcoin 30 Day Historic Volatility Index Futures, BVOLG15.

Data: Bitcoinity

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