So just a short background about myself. I used to be a Delta One trader here in Hong Kong at Citibank primarily responsible for market marking exchange-traded funds on the Hong Kong and Singapore Stock Exchange. Fortunately I lost my job at Citi and I discovered Bitcoin and that’s how I sort of got thrown into this whole arbitrage arena. Back in 2013 the first futures exchange opened and it was a bunch of Russian dudes, no one knew where they were, there was no company, just a shitty HTML website and that was the futures landscape. What I saw at the time was you could make 200% per annum applying the most simple financial strategies that I did at my regular job and then I brought those over to Bitcoin. Now those returns have come down a lot as more attention and there’s more platforms offering these products. But you if you compare the return you can earn doing similar strategies to stock index futures you can make a lot more money, if you’re willing to take the risk and invest the time in learning, that’s what I’ll be talking about today. First, just a little bit about BitMEX, we launched in November of 2014. In the last two years we’ve done about 2.6 billion US dollars of turnover on our Bitcoin and Altcoin derivative products. We just recently became the largest Bitcoin / US dollar exchange by turnover, we do anywhere between 10 to 15 million US dollars a day on our Bitcoin / US Dollar products, and we have over 15,000 registered users. Alright, so let’s just get into Bitcoin futures. So this is very conversational so if you do have any questions put up your hand and I’ll try to answer then. I’m assuming that everyone has some sort of financial services background, so I might use some terminology that maybe some of you don’t understand so just raise your hand and make me clarify. So the most popular type of futures contracts that exist right now are quarterly contracts, meaning they expire every three months. March, June, Sept, and Dec futures. We currently have US dollar, Chinese Yuan and Japanese Yen denominated futures contracts vs Bitcoin. Each one of these contracts has a different multiplier, basically what this means is what you’re trading is a fixed amount of some fiat currency in Bitcoin, and I’ll go over why we do that in a few minutes. Settlement day is the last Friday of every month at 12:00 UTC. We take a 30-minute TWAP between 11:30 and 12:00 on settlement day and that’s where we come up with our settlement price, and everything is cash settled in Bitcoin. So BitMEX and all of our competitors are all purely Bitcoin exchanges, so you can’t give us dollars, you can’t give us Hong Kong dollars, you can’t give us another digital currency, you can only give us Bitcoin. We happen to offer the highest leverage of any exchange globally on our US dollar and CNY products. It’s a 100x leveraged meaning an initial margin of 1% and we call your position or liquidate you when you get to 200x leverage which is 0.5% – that’s quite fun when you’re trading the most volatile asset in the world. So the structure that us and everyone in the industry uses for our futures contracts is an inverse structure. So this is an example ticker, this is our Dec 16 Bitcoin / US dollar futures contract. As I said, your margin, your profit and loss, are all denominated in Bitcoin. You will quote your price in US dollars. Now, because we are settling everything in Bitcoin, but we’re quoting in US dollars, some funny math has to be done. So instead of trading Bitcoin / US dollar which you would expect, you’re actually trading US dollar / Bitcoin. So the inverse of the pair that we’re used to seeing. Now this is because Bitcoiners are extremely lazy, they want to see everything in US dollars, that’s what they’re used to. They don’t want to quote an amount of Bitcoin per US dollar. So what the first exchange that opened in around 2011 did, was came up with this structure. Where basically the contract value is a negative number. You’ll never see this negative number on our frontend, but if you go into our engine logic you’ll see that our contract value is negative. That’s because you’re trading the reciprocal. Now this has interesting effects that I’ll show right now. So all this will be made available afterwards if you want any of these spreadsheets or the presentation. So here I have this Dec 16 Bitcoin / US dollar future. We have a negative 1 US dollar contract value, and let’s say we trade 10,000 contracts. Now each contract is worth 1 US dollar, so when we put a number of contracts, that’s the US dollar amount of Bitcoin that we’re trading. Now the Bitcoin value of that will depend on price, essentially we’re talking about a 1/x function. So let’s assume that Bitcoin / US dollar price is 100, and 10,000 dollars is worth -100 Bitcoin, very simple. You’ll see this is displayed as a negative number. The reason is, let’s assume that you go long this contract, you are long Bitcoin. If you increase the price to 200 the value in Bitcoin goes to -50 Bitcoin, just if you just do a last minus initial calculation you come up with a 50 Bitcoin profit. Now if we changed the sign to positive, then the math doesn’t work when you go long these contracts and the price rises. Alright, so this is a very important graph understand the behavior of these contracts. Now essentially I have just plotted the price of Bitcoin from 25 up to around 750 dollars, and I have showed the value of these long 10,000 contracts in Bitcoin terms and in US dollar terms. Now what we can see is that the US dollar value of this contract is fixed regardless of price of Bitcoin. So when you trade these contracts you are locking in the US dollar value of Bitcoin at any price. As we see here we have a classic 1/x function asymptotic out to infinity and 0. So what this basically means is, if you go long this contract, the maximum gain that you can make unlevered is 100%. Because you’re actually trading the reciprocal, the reciprocal can only go down to 0, so when go long this contract I’m actually going short US dollar / Bitcoin. If you go short something the maximum you can go to is 0 meaning you’ve actually only made 100% whereas your loss can go to effectively infinity. So what this means is, if you go long these contracts and you put up margin in Bitcoin, if the price falls 50% you lose all your money, which is contrary to what you’d believe is that I fully margin a position and price can drop to 0 before I lose all my equity. So essentially, because of the way that we need to trade and the way clients want to view their positions, you’re actually trading a quite exotic derivative. Most people don’t understand this, but this has interesting implications when it comes to how your positions are margined, because again, everything is margined in Bitcoin and not US dollars. Alright, so essentially what arbitrages in Bitcoin involve, as with anything, is creating synthetic US dollars by combining Bitcoin and Bitcoin derivatives. Now most people of the people in this room who own Bitcoin are obviously very bullish Bitcoin. They’re bullish Bitcoin because it’s either going to be worth a lot of money, like tens of thousands, millions of dollars. If Bitcoin is compared with gold or what not, or it’s used as frequently as Visa or MasterCard. Or it’s going to be worth nothing or very close to nothing. So essentially when you’re buying Bitcoin, you’re buying a call option, and your upside is massive and downside is limited to what you put in, i.e. your premium. Obviously this isn’t lost on everyone in the Bitcoin space. We’re all greed speculators. So essentially speculators are willing to borrow unsecured US dollars on different trading platforms to buy Bitcoin. The question is, who is going to lend these US dollars to these speculators? That would be anyone who is arbitraging the difference between futures prices and spot. So, essentially what we have done is created a sort of Eurodollar market where Eurodollar is basically long Bitcoin plus short futures, and I’ll show in a subsequent example why, regardless of the price of Bitcoin, if you have this position, you effectively have created dollars and you are lending these dollars and earning a return on them. So futures in Bitcoin tend to trade in contango and that’s basically because again, speculators thinking the price of Bitcoin is going to skyrocket to some ridiculous level, are willing to pay very very very high interest rates. Essentially, what this interest rate represents is the unsecured rate of US dollars plus counterparty risk. Counterparty risk is very very real. Bitfinex, which used to be the largest Bitcoin / US dollar exchange, was hacked for 70 million dollars earlier this year, which was the second largest hack of Bitcoin. In 2015, Bitstamp, another large Bitcoin / US dollar exchange, lost 5 million dollars. The year before that, Mt Gox lost half a billion US dollars worth of Bitcoin. Which basically means, if anyone holds US dollars on a Bitcoin exchange, they’re very afraid. Which basically means that the amount of US dollars that are able to lent to speculators to borrow is limited, therefore the rate of return needed to coax you to give your money to an exchange needs to be very very high. So, the simplest arbitrage strategy is cash-and-carry. Essentially, you will purchase Bitcoin with dollars or Hong Kong dollars. You will need to margin your position, you will send a portion of that Bitcoin to BitMEX, the rest, the majority of your funds, you will send to a cold wallet or any wallet that you control the private keys of, that is off an exchange. You will sell futures contracts to lock in the US dollar value of your position and then you’ll earn the difference between where the futures is trading and where the spot is trading. At expiry you’ll either realise that position by selling the profit or loss on futures contract plus your long position in Bitcoin, or you’ll continue rolling your futures positions. Alright, so this is a very simple example. Let’s assume you have 10,000 US dollars… Alright, so let’s assume with have 10,000 US dollars, Bitcoin spot price of 100, and let’s assume that our Dec futures contract is trading at 120 dollars. So first step, we go send our 10,000 US dollars to an exchange, we buy 100 Bitcoin. So now we need to calculator anticipated profit. Our anticipated profit going to be in Bitcoin, not in US dollars. So not only do we have delta on our principal, we also have delta on the profit that we anticipate to make by the time futures contract expires. We’ll need to hedge that as well, so we know we’re going to make 2,000 US dollars which is basically just a 100 Bitcoin times the difference between the spot and the futures contract. So essentially you have 12,000 US dollars that we will have at the end by the time the futures contract expires. So very simply we need to sell 12,000 contracts of this particular futures contract. We have 12,000 dollars of Bitcoin that in order to hedge, we have sold 12,000 dollars of future. Very simple. Next step, sit there and wait until the end of December until settlement. Now here is just a little representation of why regardless of where the price of Bitcoin settles at expiry you will have 12,000 dollars. So here we just have a bunch of settlement prices, this is the value of 100 Bitcoin that we purchased at this price, this is our profit and loss on our futures contracts in Bitcoin, remember, our profit-and-loss is denominated in Bitcoin, not in US dollars, so at the end we need to convert this Bitcoin profit into US dollars, that’s the US dollar value of our PNL, and that is the sum in US dollars. And as you see, regardless of where the price of Bitcoin ends up we have made a 20% profit on our money. Alright, so just a bit about settlement. On our particular exchange, settlement is a 30-minute TWAP and we take one minute slices over those 30 minutes on the reference exchanges. As I said the futures are cash settled in Bitcoin. Now obviously you don’t want to just do this trade once, you want to continue to roll your futures contracts after every expiry. Generally speaking, the longer dated futures contracts, i.e. quarterly futures contracts, roll expensive. So by the time the December 30th comes around you can buy back your Dec 16 futures contract and short H17 again, to put on another funding trade. Now we experimented with offering calendar spreads between the different expiries, but many traders didn’t understand them, so we kind of ditched it. But now that we’re thinking about bringing those back so you can actually, as you would trade HSCEI, HSI rolls every month, you can trade the roll between different quarterly contracts in one atomic operation which is much easier than manually going buy/sell. Here is a real life example of how much money you could actually earn. So this particular contract, our Dec 16 Bitcoin / US dollar contract was listed on the 27th of October of this year. Now, this is basically the outright difference between the futures contract and spot. So as you see here, these are the different interest rates you could have earned by putting on this funding trade, and obviously they’ve tended down towards 0 as the time value evaporates from futures contract. But, as you can see these are very very high interest rates when you compare them to other things that you can be trading in regular equities or FX or commodities. Alright, any questions on that? If I put this trade on, on the 4th of November I would have earned 6%, that’s it, then sit and wait. On December 30th you would have made the difference. So, quite volatile right, the prices? This is the basis, basically. But the actual futures are quite volatile, could you talk a little about the liquidity of those futures and then if there is a mark-to-market you’ve obviously got to post additional margin against that, saying you have cold-storage, getting it to you, how easy is that?
This particular contract trades about 3 to 5 million US a day, in volume, and yes they are quite volatile. So what I usually recommend is take 90% of your Bitcoin that you have bought and put it in cold storage. Take 10% and put it on the exchange as margin. As I said you can go up to 200x leverage before you get called, so you’ll have sufficient time once the thing starts moving against you, to get your money out of cold storage and then put it back on the exchange to cover your margin. Do you have intra-day calls?
Yes, it is automatic so if you breach your liquidation price, that’s it. There’s no end of day marking.
But going from your cold storage, I mean, how do you actually do that? So some people can do it programatically so they have bots that will see their liquidation price and automatic top-up their account. Some people, if they really trust us as BitMEX and want to take our counterparty risk, will fully fund this trade. So if I buy 100 Bitcoin I take the 100 Bitcoin and put it on BitMEX and then short the equivalent amount of futures contracts. That effectively is US dollars, and levered at 1, regardless of the price of Bitcoin. So you’ll never get called if you do that, but then again your whole principal plus interest is subject to our counterparty risk. This is the live market for Dec 16 so about 0.50 dollar for 3,000 bucks and then it get’s a little bit wider so about 1.50 dollar you can get 30,000 dollars and I’m done. But most these are market makers so if you have an algo that’s trading this you can just do TWAP or an iceberg order and then you won’t be eating through a lot of book. Alright so the next strategy, probably a little bit more simple. What a lot of people get started doing is arbitraging the difference between different Bitcoin exchanges. It’s very common than exchange in Hong Kong and an exchange in say Europe will have a different price and since Bitcoin is fungible and US dollars are fungible you can arb the difference between these exchanges. The only problem with doing this arb is that you need to have Bitcoin at the ready to sell immediately when you buy it, and that exposes your collateral to price risk. So what more sophisticated people who do arbitrage between different spot changes do, is they hedge or they earn carry on the Bitcoin that they’re using to do arb with. So essentially what you’ll do is take your money and split it into a portfolio of US dollars and Bitcoin. You’ll take your US dollars and deposit them on the historically exchange the trades cheap. You’ll send a portion of your Bitcoin to BitMEX for margin on your futures trade, and the rest of the Bitcoin you’ll send to the exchange that historically trades expensive and then when you see an opportunity you buy cheap, sell expensive, and now you’ll rebalance your portfolio move money back where it came from and repeat the process. Now in 2013 this was a very very lucrative way to trade. In China you could make 40% return, so as fast as you could get your CNY out of China back into Hong Kong is as fast as you could earn another 40%. and so that particular spread lasted for about 2 to 3 days. Recently in Japan you can earn between 5% to 10% immediately per turn. Basically the price of Bitcoin in JPY terms is trading 5% to 10% above where it trades internationally, and that’s basically because Japanese people don’t trust non-Japanese people and non-Japanese people don’t trust Japanese people. So no-one’s willing to send money to each other’s exchanges, so the prices go like this, and this has probably existed for the past 2 to 3 days and it seems like it will continue to exist. So I’ll show you a quick example. Alright, so say we have 20 grand. Bitcoin the futures contracts we use 10x leverage We our split our portfolio into dollars and Bitcoin You’re earning carry on the Bitcoin that have doing this arb. This just shows the operation of buying and selling assuming I’d say the expensive is at 100, cheap is at 90, you make 1,000 dollars on the trade. Now this was very easy to do manually, three years ago. Nowadays most people have automated trading systems that do all this, and as they notice arbs across the world, they just buy and sell, buy and sell. It’s especially common in China where there are no trading fees So, the only thing that really matters is the withdrawal fee of CNY between the different exchanges, so effectively your ability to earn money is constrained by how fast you can process fiat deposits and withdrawals, and how much that costs, on average for you as a trader. This is just a quick chart of the visualisation of the different arbs across the world. You can find this on Bitcoinity. they produce nice little chart. One very lucrative way to make money is LocalBitcoins. Once upon a time I was the largest LocalBitcoins seller in Hong Kong. My first Bitcoin I bought from him actually, on LocalBitcoins. So because LocalBitcoins is essentially an escrow service, so as a seller of Bitcoin I basically deposit Bitcoin on LocalBitcoins and post advertisement saying I am willing to take say Western Union, or MoneyGram, or Hong Kong bank deposit, and I’ll send you Bitcoin once I get my money. Now fees on LocalBitcoins are very very high. We won’t tell you exactly where you are in the queue, and that’s because we don’t want to expose too much information about the liquidation prices of other traders in general. Once you think this is really awesome and I want to go make some money. The next thing is how do you buy Bitcoin. So these are some of my recommendations. If you want to buy Bitcoin on an exchange I would suggest Bitstamp or OKCoin. Bitstamp has bank in Slovenia, OKCoin has a bank in Taiwan. Usually you can get your money on the exchange the same day, so if you send a wire from HSBC before 12:00, I usually get my money to Bitstamp by the afternoon, or morning in the EU. OKCoin’s bank is in Taiwan, similar sort of timescale. If you don’t want to deal with an exchange, you go to LocalBitcoins, there are people who are posting ads on there and you can buy Bitcoin in a matter of half an hour or an hour, basically just send somebody a bank wire to their bank. They’ll send you Bitcoin and then you’re on your way. I bought my first Bitcoins on Mt Gox and luckily I got out of there before they went belly up. If you want to trade Bitcoin in China that’s a little bit trickier, you’ll probably have to take a bus to Shenzhen, go to a bank, open a bank account, and then you can open an account at a Chinese Bitcoin exchange. If you want to try out this Japanese Yen trade I was talking about, there’s an exchange called Quoine. They allow you to set up an account and you don’t need to have a domestic Japanese bank account to get verified. I’m today I was doing some checking around on the other large Japanese exchanges, but just about all of them require you to have a domestic Yen account at once of the large banks which is practically impossible unless you’re Japanese. Which is why there is this arbitrage opportunity. So in terms of how do I store my Bitcoin, which is again, as I mentioned is very important. If you don’t have the private key you don’t own the Bitcoin. At sometimes exchanges get hacked that’s just part of the game. BitGo is an online wallet, very good company, they try to excel at doing security for Bitcoin, the only downside to BitGo is every outward Bitcoin transaction they charge you 0.1% this is just a recent development that I discovered a few weeks ago. If you’re willing to put in a little bit more effort there are obviously are clients which don’t charge you to send your Bitcoin out of the environment. In terms of the desktop wallet, Electrum is one of the best desktop wallets. There used to be a company called Armory that offered one of the most robust desktop wallets as well. You want a mobile wallet, something called Mycelium is available on Android and iOS. Just a word of note, when you create any of these accounts they’re going to give you some backup codes. Best practice is to print out these backup codes and take them to your security deposit box wherever that maybe or some secure storage facility and put them there. Because invariably, you will forget your password, you’ll ding your computer and lose your hard drive, but, if you have those backup codes you can recover your Bitcoin. If you do not have those backup codes your Bitcoin is gone forever. So when they ask you to do these backup procedures, pay very close attention and follow the instructions. Now if you want to get setup with a Bitcoin exchange, the process usually takes between 1 to 3 business days, and as I said, they do KYC, so you’ll need a government ID, address proof, and a bank statement. Generally 1 to 3 days to get setup. If you’re really serious about this, you go to just about every exchange and set up accounts, it’s a bitch to do, it takes a little while, but, when you see that arbitrage opportunity and you’re already setup, there you go, then you can make money. Then on BitMEX it is very simple, all we require is an email address and Bitcoin, because we only deal in Bitcoin, we don’t deal any in sort of fiat currency. Alright, so we have futures contracts and one of the new products that we innovated on is a Bitcoin swap. So one of the problems that we noticed with a lot of our clients, was that they didn’t like settlement, they didn’t understand it. Why did my position go away? So we thought, how can we create a non-expiring derivative? So what we thought of was a total return swap. One issue of that is how do we determine what the interest rate is to charge between long and shorts, to entice people to take the other direction of a trade? So what we did was, we said we’ll do a look back on the average premium or discount that the swap traded against the spot market and we’ll charge that as a funding rate for the next period, so what that means is, if the market is ripping and the swap is trading at a massive premium next period, if you short that swap you’re going to receive a payment, and if you go long you’re going to pay, and these interest rates can get quite high. Right now every 8 hours the maximum it can go is 37.5 basis points, it used to be 100 basis points. So you can have a situation where if the market is really trending, you can make over 1% a day in just interest costs and you can put on a hedged position. Does the interest reset daily?
The interest resets every 8 hours. So some clients, and some market makers do a funding arb on the swap. Again the swap is just another form of synthetic US dollars. Long Bitcoin plus a short swap are essentially dollars that you’re lending to speculators. If the funding rate is positive you as a short holder of the derivative are paid, if the funding is negative you pay. Now, if you put the on strategy since we launched this product in May of this year, you would have earned 30% outright, and that’s just from shorting the swap, holding Bitcoin and doing nothing. I don’t think the price of Bitcoin has even risen 30%. So this is is quite a lucrative strategy if you just want to earn interest basically, that’s because this product is leveraged 100x. So you’re essentially lending a bunch of speculators a lot of money. This is just a very simple example of how we calculate our funding rate so between periods we look where this swap is trading vs the spot price, and in practical terms we take a 8-hour TWAP with one minute slices of the premium that is observed and then we charge that in the next period. So if you log on to BitMEX you know what is the amount of money I am going to have to pay my position at the next funding time. Now this is discrete period so if you hold the contract over funding, you are charged, if you get out right before funding is charged then, you pay nothing. So what you see is what you would expect on a floating rate bond essentially, is a see-saw effect of the price of the swap. We charge on the notional of the position at the time and so this is just a simple calculation of how much you would pay in interest. This is our Bitcoin / US dollar swap, as I said this is our most popular product. as we see here it says funding rate of a very small amount in 33 minutes. We also tell you the projected rate so the next 8 hours to be charged at 20:00 UTC which is 4am Hong Kong time. If you’re long you’ll pay pretty much 1.5 basis points on the notional of your position, if you’re short you’ll receive that amount.
So putting this into practice, let’s assume they want to create 100,000 US dollars they’re going to lend synthetically. Bitcoin is at 100, swap is at 100 dollars. What we have noticed empirically with the swap price is that this interest rate mechanism has been very effective. Our swap trades pretty much at the spot price even when it’s leveraged 100x, which is exactly what we want. So let’s assume we purchase 1,000 Bitcoin and we sell a 100,000 contracts. The swap has the same inverse structure as the futures contract that I spoke about previously. Now I’m just going to go through a one period PNL, assuming the funding rate of 25 basis points, so essentially your interest income is 2.5 Bitcoin. Now if you’re going to continually put this trade on, you want to re-hedge your interest income so that you continuously compound your earnings, to achieve an even greater return. So this 2.5 Bitcoin is worth 250 dollars, so we short additional 250 contracts at the end of these 8 hours. Now this particular trade, if you just want to sit on it and not have to monitor it all at, I recommend fully funding it on BitMEX. Which basically means you have no liquidation price, because essentially you have created a 1x leveraged product. This table essentially demonstrates that point. Even if I take the price down to 1 dollar or I take the Bitcoin price up to 1000 dollars, my leverage doesn’t change if I fully fund my position. Now the only value where we get undefined is 0 because what is 1/0? So if Bitcoin goes to 0 then all this math kind of falls out the window. Alright, so that is pretty much the end of our remarks on arb. Some additional resources, we have a sample Python market making bot in GitHub. If you are programmatic inclined, you can use this. If you are comfortable with APIs and what not, I highly suggest getting up to speed on this. I can count the number on my hands people who actually do real market making or arb using these algos and they make a lot of money. We have a blog, I post routinely, do different trading ideas on our contracts. We have a YouTube channel where I have different lessons on some more advanced strategies and spread trading and curve trading using the different futures contracts and then example spreadsheet that I have shown here, they’ll be made available publicly, so that’s all and any questions?
Do you know the breakdown of volume going through the API vs people going through the UI?
I’d say that our main market makers probably represent 75% of the volume, and that’s just because they’re quoting two-sided markets all day. The good thing about our platform is, if you post a passive limit order or a post only order, you get 2.5 basis points rebate so it doesn’t cost you anything to trade.
You make liquidity you get paid, if you take liquidity then you’ll pay 7.5 basis on the majority of our products. What’s the average leverage the clients are taking on your exchange?
Most clients take 10x. What’s the middle rate, why do some of these arb still exist? Because the majority of Bitcoin traders are technologist background, they don’t understand finance. They understand this technology is amazing, I think Bitcoin is going to a million dollars. They don’t recognise that they’re paying a lot of interest to get that leverage, and as I said it’s counterparty risk, and lack of knowledge that this even exists. So when I was trading, I was getting 200% per annum returns on these strategies. One strategy, when the market was going absolutely ridiculous, you could sell a March 2014 future 100% outright return in December, so doubled my money in three months. Basically by putting on short March, long Dec. So these things, no-one knows about them because it was a very small industry, it’s still very small. The amount of traders that are doing these types of things is probably 10 to 20 that are actually providing the majority of liquidity to whole Bitcoin market. So if you’re going to short the swap, and you’re fully funded, it doesn’t matter the price?
You don’t care what price is. You just care that I am going to make this interest rate. Now, could you have made more money if you just went long Bitcoin? Maybe but then you need to time the market correctly. This is a strategy it’s just like a bond. Alright, thank you all.