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BitMEX Crypto Trader Digest May 23, 2019
From the desk of Arthur Hayes
Co-founder & CEO, BitMEX

From The BitMEX Engine Team

BitMEX Technology Scaling, Part 2: The Road to 100x

Today, we’re offering Part 2 of this series — a deep dive into overload and problems inherent to horizontal scaling. We will discuss the results from our efforts so far in handling unprecedented volumes and will detail the parts of the BitMEX engine that must remain serial, the parts that can be parallelised, and the benefits of BitMEX’s API-first design.

From The BitMEX Research Desk

The Lightning Network (Part 2) – Routing Fee Economics

Abstract: BitMEX Research examines the market dynamics of Lightning network routing fees and the financial incentives for Lightning node operators to provide liquidity. We identify the interrelationship and balance between Lightning routing fees and investment returns for channel liquidity providers, as a major challenge for the network, rather than the computer science aspects of the routing problem. We conclude that if the Lightning network scales, at least in theory, conditions in wider financial markets, such as changing interest rates and investor sentiment may impact the market for Lightning network fees. However, regardless of the prevailing economic conditions, we are of the view that in the long term, competition will be the key driver of prices. Low barriers to entry into the market could mean the balance favours users and low fees, rather than investment returns for liquidity providers.

(Photo source: Pexels)

The Schnorr Signature & Taproot Softfork Proposal

Abstract: We summarise and provide context for a recent Bitcoin softfork upgrade proposal, which includes a new digital signature scheme (Schnorr), as well as a complementary upgrade called Taproot, which adds new capabilities that extend Bitcoin’s smart contracting capability. The upgrades are structured to ensure that they simultaneously improve both scalability and privacy. Other than increased complexity, there are no significant downsides to the proposal, and the most controversial aspect of it is likely to be the lack of other anticipated features. We conclude that although many will be enthusiastic about the upgrade and are keen to see it rolled out, patience will be important.

(Photo source: Pexels)

Bitcoin Cash SV – 6 block chainsplit

Abstract: On 18th April 2019, the BitMEX Research Bitcoin Cash SV node experienced 2 block re-organisations. First a 3 block re-organisation, followed by a 6 block re-organisation. In this brief piece, we provide data and graphics related to the temporary chainsplit. The chainsplit appears to be caused by large blocks which took too long to propagate, rather than consensus related issues. Our analysis shows there were no double spends related to the split.

Initial Exchange Offerings

Abstract: In this piece we present data on a relatively new phenomenon, Initial Exchange Offerings (IEOs). The ICO market is down around 97% in Q1 2019 (YoY), based on the amount of capital raised. In this relatively challenging climate to raise funds, some projects have changed the “C” in ICO to an “E”, perhaps in an attempt to assist with raising capital. At least for now, to some extent, this appears to be working, with almost $40m having been raised so far this year. However, we remain sceptical about the prospects for long term investors.


Let's Go Choyna!

In America, the “heartland”, “rustbelt”, “flyover states” and “insert your euphemism for underemployed workers”, have not participated in the tech and finance bull market from the 1980s until the present. Trump rode the wave of this disaffection to the White House, and he panders to his constituency with China bashing. Oh, and you best believe he is going to wipe the floor with the Democrats in 2020. I will trade SIZE on this prediction.
In China, the rural-now-urban peasants left their villages to work in factories mass-producing knick knacks at affordable prices for American soccer moms. 30 years on, Xi Jinping and the Politburo must continue to generate wage growth to keep the peasant horde happy. In the absence of actual demand, that means China prints money to continue to support heavy industry and manufacturing.
Both America and China need a market for their labour. The trade war is a manifestation of this conflict. Unfortunately, win or lose, this “war” will not solve the structural economic issues that keep the plebes plebeian. It is a convenient distraction for both Trump and Xi.
The unfortunate part for China is that it lacks a well-functioning consumer economic participation to create homegrown GDP growth. Instead, China relies on money printing to generate economic activity. The trade war, while pointless in the long run, pushed China to continue to print more and more money to keep growth numbers at “acceptable” levels.
I subscribe to the view of Michael Pettis that GDP is a political number. Beijing chooses a GDP growth rate, then prints money to hit the target. It does not represent the true economic health of the Chinese economy. I highly suggest anyone serious about understanding China macroeconomics to subscribe to his newsletter. It’s pricey but worth every penny.
So Back to Bitcoin
Bitcoin is a monetary asset, and the flow of money and credit is crucial to understanding how the price will perform in the future. The Fed and PBOC are committed to increasing the size of their balance sheets in 2019, that is positive for Bitcoin.
The reason I focus more on China is the scale of credit creation each year dwarfs any country ever in human history. The other important consideration is Chinese people have no illusion about what is actually happening. Unlike their American counterparts, ordinary Chinese people do not trust the government.
Americans love America. Walk around an American and city, and you will see countless people wearing American flag paraphernalia. Walk around a Chinese city, and you are more likely to see a Balenciaga handbag than someone rocking the Chinese flag as a fashion statement.
China has devalued and revalued the Yuan multiple times since the early 1980s. This is not lost on the population. The PBOC has kept the Yuan relatively stable since early 2017. They even made moves to actually tighten credit conditions. However, the trade war changed all that, and now they are printing money like it’s 2008. That pressure will build around the exchange rate, and at some point, either the PBOC tightens credit and slows GDP growth, or devalues.
Chinese asset holders are not stupid. They see the writing on the wall, and as the CNY has recently crept higher towards the magical 7.00, Bitcoin exited the doldrums and more than doubled.


The charts above show the USD/CNH (this is the offshore CNY) and the Bitcoin / USD price performance during two time periods, June 2015 – December 2015 and January 2019 – May 2019. The charts show that Bitcoin performs well during periods of rapid Yuan depreciation.
The wrinkle in 2019 is that the major Chinese exchanges no longer offer Bitcoin / CNY trading. Now Chinese traders must obtain Bitcoin in the Chinese OTC markets. Make no mistake, just because you don’t see Okcoin and Huobi putting up big volume numbers in China, doesn’t mean they have stopped serving the Chinese market. The OTC market is vibrant, and these venues have found politically acceptable ways to allow buyers and sellers to meet in China.
Zhao Dong, arguably the largest OTC trader in China, is one of the main people responsible for the successful $1bn Bitfinex LEO IEO. He went on the record supporting Bitfinex to the Chinese crypto community, and his clout and network helped Bitfinex win back the Chinese traders. China still matters.
The key number is 7.00. If the PBOC allows the Yuan to break this level, ordinary Zhou’s will scramble to get their hands on Bitcoin and other cryptos. Similar to 2015, a sharp and sudden Yuan depreciation could lead to the beginning of another epic bull market.

Replace C with E

When in doubt, change the name. ICO is a dirty word these days, so let’s just call them IEO’s (Initial Exchange Offerings). 2019 marked the beginning of the IEO market. BitMEX Research wrote an excellent piece examining the beginnings of the IEO market.

With an ICO, any schmuck with an internet connection could put up a makeshift WordPress site, a Bitcoin or Ethereum address, and a poorly written whitepaper. Fast forward a few months, and the team became crypto millionaires. After the lawyers and regulators scared off everyone, the ICO market died.

The IEO market rose from the ashes. Instead of just anyone raising money, the exchanges with the most vibrant user bases became the gatekeepers. It makes sense, ICO projects all jostled to get onto Binance, Bittrex, Kraken, Bitfinex etc. You can’t pump an ICO without a coterie of speculators, which successful exchanges bring to the party. Instead of allowing a bunch of amateurs financial token advisors take the vig, the exchanges completely cut them out of the process.

The most straightforward IEO investments are in the exchanges themselves. Binance pioneered the exchange token space with its BNB token. Binance pledged that it would buyback BNB in the market with profits generated from the exchange. To encourage traders to hold BNB, Binance gave fee discounts and recently required punters to stake BNB to participate in hot IEO deals.

ICO mania treated Bitcoin and Ether very well. The more people that heard about the insane returns trading ICO’s, the more people who entered the crypto ecosystem. The first asset they naturally bought was Bitcoin or Ether. Even if some of that money transitioned onto shitcoins, a lot of it stuck around.

The question during this crypto winter is, what new thing will cause speculators to pile back into the crypto capital markets. Enter Bitfinex!

The Tether / Bitfinex saga entered a new stage when payment processing firm Crypto Capital was unable to give Bitfinex access to its money. Bitfinex took a “loan” from Tether, and once this was exposed via the NYAG, Bitfinex had some ‘splanin’ to do.

When in doubt IEO!! Bitfinex used the new shitcoin IEO wrapper to issue the largest exchange token ever. They planned to privately raise $1 billion to plug the Crypto Capital hole and keep Tether backed 1:1 with USD cash money.

The community rallied behind them. In under two weeks, the Bitfinex LEO exchange token raised $1 billion from private individuals. This is truly amazing.

Read the LEO whitepaper and an S1 for an IPO in the United States. You will quickly realise the LEO whitepaper is about one ton lighter in the material than an S1. No matter, the trading community piled in.
The Capital Structure?

Where does an IEO sit on the capital structure of a company? That is a great question. In the case of exchange tokens like BNB and LEO, it appears you have no rights. That doesn’t mean the cash won’t flow, but the exchange can change the rules of the game as they see fit. The only check is the willingness of the community to continue supporting said exchange by paying fees.
Exchanges that focus on the community and do right by it will generally outperform those that don’t. Binance is a great case study in an organisation that took the top spot by giving the crypto traders what they wanted. They wanted shitcoins, they wanted a charismatic CEO, they wanted SICK GAINZ!!
In the shitcoin game, Binance listed everything and created a community of die-hard fans. Exchanges like Poloniex were not able to keep the mindshare of traders and got smoked by the upstart.
Do you have any legal rights as the holder of an IEO exchange token? Maybe. That being said, if an exchange abuses the community long enough, someone will take their place. Anyone can open an exchange, and there are plenty of white lable tech providers that will happily take $100k and give you a subpar matching engine. Would be usurpers see the fees generated by the top players and want in on the action. That is why crypto is different than traditional asset trading. If you wanted to create a traditional stock exchange, good luck! I hope you have a few hundred million USD of capital and like waiting for Godot.

Bull Market Baby
If Bitfinex can raise the largest ever IEO in under two weeks, the community is feeling good about itself. Traders spent the last two years repairing their balance sheets. They are striking out now at the new shiny bauble. Buckle up, buckaroos!

Convexity - Rektum Damn Near Killed ‘Em

Since BitMEX launched on 24 November 2014, cryptocurrency derivatives trading exploded. I tried in vain to seduce various venture capital firms with the vision of the future that was all about derivatives trading. At that time, succour was not forthcoming; however, I could not be more pleased with my failures now standing in 2019.
The BitMEX XBTUSD perpetual swap and various other contracts traded on OKEx and Deribit are of the same ilk. These contracts all allow you to trade a fixed USD amount of Bitcoin. We call these inverse derivatives contracts. Many OG traders have heard me speak at length about the subtle yet profound implications of this contract structure. However, as many new traders now try their hand at derivatives trading, a refresher course is necessitated.
Contrary to popular belief, I don’t delight when I see the BitMEX Rekt twitter feed going bananas. I’m long-term greedy. I would rather you enjoy a long trading career earning a profit and paying BitMEX trading fees along the way, than blow up your equity capital during a liquidation. Therefore, it is in mine and BitMEX’s best interest that our traders are sufficiently educated about best trading practices.
I love our traders, but when I hear people smile and laugh about getting liquidated it makes me cringe. A real trader practices proper risk management, and that means never being liquidated.
You Gotta Go Down, To Go Up
Convexity or gamma is the second derivative of a contract's value with respect to price. Used correctly convexity can supercharge your portfolio’s returns. However, if you do not understand how convexity affects a derivative you trade, you will get rekt repeatedly.
With inverse contracts, the margin currency is the same as the home currency. I will use the XBTUSD contract throughout this post.
Home Currency: XBT (Bitcoin)
Foreign Currency: USD
Margin Currency: XBT
USD Value: 1 USD
XBT Value: 1 USD / Price (XBT/USD exchange rate or .BXBT index)
I will dwell on how the XBT exposure of a long 100,000 contract position changes with respect to the price (.BXBT Index).


First, let’s look at the long side. In bull and bear markets, these will most likely be speculators. This makes sense because being long Bitcoin offers asymmetric returns. Bitcoin can rise to infinity, but can only fall zero. It is better from a return on equity perspective to go long the bottom, then go short the top. Those who picked up ETH below $100 know this acutely. Therefore, coupled with leverage, on the margin, longs in most market environments will be predominately speculators.

The first chart shows XBT PNL profile and curvature. The straight line is the PNL %  return if the contract moved in a linear fashion, the curved line is the long inverse contract position’s PNL % return. What you immediately notice is that you will lose more money when the market falls, and make less money as the market rises. This is suboptimal as you must post margin in XBT. Thus, your margin requirements increase in a non-linear fashion, and this is why longs get rekt quickly in a falling market. 

Now let’s examine the short side.  In bull and bear markets, these will most likely be hedgers and market makers. In both cases, these market participants want to lock in the USD value of Bitcoin. With inverse contracts, a long physical Bitcoin position coupled with an equivalent short XBTUSD position creates a synthetic USD position. If 100% of the physical Bitcoin is placed at cross-margin with BitMEX, you cannot be liquidated.
Unlike the long side, shorts benefit from positive XBT convexity. Shorts make more and more XBT as the price falls, and lose less and less as the price rises.
The take away from these two examples is that long speculators will be liquidated faster on the way down. This explains why dumps in these derivatives dominated markets are now more extreme than pumps and will continue so long as inverse style derivatives dominate the cryptocurrency derivatives markets.
The CME contract has a fixed XBT exposure regardless of the price, and the USD exposure varies linearly with respect to price. While this is great for USD benchmarked investors, it becomes problematic for those hedging their exposure. Bitcoin purchased to hedge a short CME position cannot be used as collateral with the CME. This presents some challenges for hedgers who hold physical Bitcoin, and market makers who must divide precious capital between derivatives and spot markets with no cross-collateral relief.

Risk Disclaimer

This article should not be copied or reproduced in whole or in part. The information contained in this article does not constitute research or a recommendation. 

Neither BitMEX nor any of its affiliates make any representation or warranty, as to the accuracy or completeness of the statements or any information contained in this article and any liability therefor (including in respect of direct, indirect or consequential loss or damage) is expressly disclaimed. This is not providing any financial, economic, legal, accounting or tax advice or recommendations.  In addition, the receipt of this article is not to be taken as constituting the giving of investment advice nor to constitute such person a client of BitMEX.