Bitcoin Rally Fuels Market In Crypto Derivatives (#GotBitcoin?)
New structured products draw concern as digital currency climbs back above $10,000. Bitcoin Rally Fuels Market In Crypto Derivatives (#GotBitcoin?)
Wall Street has dreamed up an array of derivatives tied to stocks, commodities and mortgages. Now such contracts are being developed for bitcoin.
In recent months, some cryptocurrency firms have begun touting structured products linked to the price of bitcoin, with complex formulas determining how much they pay out.
It is still a small market, and the firms say their products aren’t aimed at mom-and-pop investors. But the trend is raising red flags among some market veterans, especially as bitcoin’s rebound above $10,000 has rekindled investor interest in the digital currency.
Craig McCann, a former Securities and Exchange Commission economist, warns that it is a bad idea to take bitcoin—a highly volatile, speculative asset traded on unregulated exchanges—and use it as a building block for complex instruments.
“There are all kinds of problems associated with any structured product tied to bitcoin,” said Mr. McCann, who now leads Securities Litigation & Consulting Group, a firm that provides expert witnesses for companies involved in securities lawsuits. “It doesn’t belong in anybody’s portfolio.”
Cipher Technologies, a crypto hedge fund in Greenwich, Conn., began offering structured products on bitcoin earlier this year. The firm has done several such deals, mainly with entities that manage money for wealthy families and individuals, said Cipher’s founder and managing partner, Gerald Banks.
“We would not fathom pushing this to anyone who would not be fully versed in the risk or in the nature of the underlying asset,” said Mr. Banks, who helped develop Merrill Lynch’s structured-products business in the 1990s and early 2000s.
One of Cipher’s products is a bond-like contract known as a reverse convertible. In such a deal, the client loans money to Cipher in return for monthly interest payments, with Cipher paying back the loan once the contract expires. But before then, if bitcoin falls below a predetermined level—a 19% drop, in one version of the product from earlier this year—then Cipher returns the principal to the client, minus the amount bitcoin has lost.
KuCoin Launches Bitcoin Derivatives Trading With 20x Leverage
IDG-backed cryptocurrency exchange KuCoin has just launched a platform offering crypto derivatives trading.
Announced Monday, the KuMEX trading venue is now live in public beta and will offer initially a bitcoin perpetual contract (XBTUSDM), quoted in U.S. dollars, with up to 20x leverage.
Aimed to make pricing “more fair and rigorous,” KuCoin said, KuMEX uses a bitcoin spot index providing a volume-weighted average of the U.S. dollar price of bitcoin across six exchanges: Coinbase Pro, Bitstamp, Kraken, Gemini, Liquid and Bittrex.
The spot index also avoids a contract being liquidated “because of the low liquidity of the trading platform or the large price fluctuations of one or two spot exchanges,” the exchange explained.
KuMEX offers some protection from risk with an insurance fund it says is “fully transparent,” with the balance to be disclosed on the platform each day.
“This fund ensures that investors who are forced to close their positions will not lose money that exceeds their position margin,” according to the announcement.
Should the insurance fund turn out to be insufficient to cover losses, KuMEX also has an “auto-deleveraging” system, said to be less “inflexible” than settlement via more standard socialised loss mechanisms.
To encourage new retail investors to get involved with crypto derivatives, KuMEX is offering a lower investment threshold than found at some other providers.
“The XBTUSDM contract value is 1 USD, which enables traders to make a more flexible investment. At the same time, KuMEX offers a negative fee for Makers at a rate of -0.025% with a certain amount of fixed commission, encouraging users to provide liquidity to the platform through making the market and earning some commission as an incentive,” says KuCoin.
KuCoin CEO Michael Gan said:
“Compared to the spot market, derivatives are much riskier due to the leverage used, so we are more cautious in providing such services. KuMEX is a derivative trading platform independently developed by our team, and from its inception, we have positioned it as a genuine and advanced financial product, so that all users can trust the platform and trade on it freely, without worrying about the loss caused by any form of manipulation. ”
After the full launch of the platform, 50 percent of net KuMEX revenue will be assigned for distribution to holders of the exchange’s token, KuCoin, the release states.
Last November, the Singapore-based exchange raised $20 million in Series A funding from investors including IDG Capital, Matrix Partners and Neo Global Capital.
3 Insights On Crypto Derivatives And Risk From Veteran OTC Traders
For all the talk about liquidity, bitcoin and other crypto-assets are thinly traded. Investors that buy and sell large volumes can’t do so directly, without slippage, or a change in the price between order and execution.
They turn to over-the-counter (OTC) desks to manage those trades, whether buying crypto for the first time, or trading to generate alpha (above-market returns).
As a result, these desks handle anywhere from 30 percent to 65 percent of total crypto market volume, depending on whose estimate you believe. To get a look inside this business, CoinDesk Research talked to two veteran OTC traders in a live webinar on Oct. 28.
Martin Garcia is managing director and co-head of trading at Genesis Trading. Yinfeng Shao is a former trader at Circle and now the CEO of a development-stage OTC firm, Reciprocity Trading.
OTC desks take on tremendous, temporary risk. Traders like Martin and Yin are tasked with managing that risk by moving large amounts quickly and offsetting it on derivatives markets, including BitMEX, Huobi, OKEx, CME Bitcoin Futures and Bakkt. (For background, CoinDesk Research has produced a white paper on the state of crypto derivatives markets. You can download it for free here.)
As a result, they are among the most sophisticated traders on crypto derivatives exchanges. Here are a few of the insights Martin and Yin shared during our hour-long conversation.
1. Investors’ Mentality Has Shifted
The mentality of investors has changed since the earlier days of crypto, from venture-like to hedge-fund-like.
“There’s a lot more velocity amongst the traders that are out there, whereas in the early days it was very much more a buy-and-hold” strategy, Martin said. “People these days understand that this market is super volatile and a lot of the different crypto funds and people that are out there, they are trying to add alpha for their shareholders.”
2. Derivatives Markets Move The Spot Market
First of all, market moves get started on derivatives exchanges more often than on spot exchanges.
“Because there are so many trading venues, it’s a constant question of, where is the action starting?” Yin said. “Often it’s starting on derivatives exchanges because that’s where a lot of people have connections and that’s where a lot of the most highly levered bets are taking place.”
“Crypto already is a fairly random, volatile walk in terms of price action and the collection of these derivatives and the exchanges that list them effectively act as leverage on top of that,” he went on. “Whenever you start to make a move, there’s a good chance it will get exacerbated because of the amount of open bets that are out there.”
In isolated examples, like the May 17 flash crash, a small amount on spot markets can cause a large move on the offshore derivatives markets, specifically BitMEX, allowing traders to manipulate the spot price in favor of their derivatives markets position.
Theoretically, that’s possible on regulated crypto derivatives markets like CME’s, but it’s more expensive and difficult because the leverage is not as high.
That’s Not The Only Way Derivatives Markets Can Fail.
“Where things tend to break down a bit and you get a lot more slippage is when you’ve simply exhausted everybody’s ability to really use the derivatives instruments to hedge, so whether that’s the amount of collateral that everyone’s posted is insufficient, or the market conditions are such that you really can’t get access to some of these platforms,” Yin said.
3. Two Products Dominate Derivatives
The most popular product is the perpetual swap, reputedly invented by BitMEX. Crypto futures are a close second. A handful of OTC desks can provide swaps and custom derivative products, including contracts for difference, but those two products have dominated market volume so far.
Bitcoin options are emerging, but remain a small percentage of overall volume. As providers including Bakkt and CME have announced plans to bring options on bitcoin futures into the markets, Yin and Martin said these may prove attractive for large investors entering crypto, looking for a hedge against a big downside in a volatile market.
“I think it means there are more sophisticated hedging strategies. It allows people to be more comfortable with spot exposure, if it can be more easily hedged out,” Martin said. “These markets move really quickly and a lot of the bigger places that want to start trading, there’s a significant amount of headline risk attached to this. How do they protect against the crazy downside move? Options may very well help eliminate some of those risks for them.”
Listen to the full webinar for Yinfeng and Martin’s unfiltered opinions on risk, liquidity and derivatives in crypto markets.
Tassat Gets CFTC Approval To Issue Bitcoin Derivatives In US
New York-based financial technology firm Tassat — formerly known as trueDigital — has succeeded in overcoming the first hurdle in its bid to launch a fully-regulated crypto derivatives exchange.
According to an announcement from the United States Commodity Futures Trading Commission (CFTC) on Nov. 7, the regulator has approved the transfer of a swap execution facility (SEF) registration from fellow New York-based financial services firm trueEX to Tassat.
Tassat had first reached the agreement in principle to acquire — subject to CFTC approval — trueEx’s SEF registration back in July of this year.
The company is now waiting for news regarding its prospective acquisition of trueEx’s Designated Contract Market (DCM) registration, which would allow it to operate an exchange listing futures or options contracts with oversight from the CFTC.
Physically-delivered BTC Derivatives For Institutional Investors
In its press release, the CFTC stated that trueEX and Tassat fulfilled the requirement for transferring a SEF registration by providing evidence that Tassat would be able to operate in compliance with the provisions of the U.S. Commodity Exchange Act and related CFTC regulations.
The agency revealed that there are now a total of 19 registered SEFs, including Tassat, and noted that TrueEX had been granted its registration as a SEF by the CFTC on Jan. 22, 2016.
The registration brings Tassat closer to launching a crypto derivatives exchange with full oversight from the CFTC, where it hopes to list physically-delivered Bitcoin (BTC) derivatives for institutional investors. As CEO Thomas Kim said in July when the plans were first unveiled:
“Adding the exchange to our ecosystem delivers a complete end-to-end offering, currently unavailable today, that encompasses tokenization, payments, market data and settlement for the benefit of our clients and partners.”
In March, Tassat — when it was still known as trueDigital — had partnered with crypto data firm Kaiko and digital assets analytics company Inca Digital Securities to widen the distribution of its over-the-counter reference rates for Bitcoin and Ethereum (ETH), the latter of which it created in partnership with ConsenSys.
TrueDigital was initially established as a subsidiary of TrueEx, which has long been active in the crypto space and was the first in the industry to secure a DCM registration for Bitcoin swaps from the CFTC back in 2012.
This summer, another crypto exchange ErisX, procured a derivatives clearing organization license from the CFTC as part of its plans to make digital asset futures contracts available for trade on its regulated derivatives market later this year.