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[bitmex]Crypto Trader Digest

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BitMEX Crypto Trader Digest Oct 13, 2017 android-chrome-512x512.png
From the Desk of Arthur Hayes
Co-Founder & CEO, BitMEX

From The BitMEX Research Desk

The SegWit2x (B2X) hardfork – How to protect yourself & potentially profit (Part 1) – How to split your coins?

Abstract: The upcoming SegWit2x hardfork lacks replay protection.  In this piece we look at what you can do to protect yourself, by analyzing various ways you could split your coins.

The SegWit2x (B2X) hardfork – How to protect yourself & potentially profit (Part2) – Potential Investment Strategies

Abstract: The upcoming SegWit2x hardfork is likely to lead to price volatility.  In this piece we look at some potential investment strategies which could allow you to capitalize on the event.

ICOs – Part 1 – An Interactive Visualization of the ICO Space

Abstract: In this week’s piece, we look at the world of ICOs. We present an interactive visualization, that illustrates the entire ICO landscape and the interconnections between people officially affiliated with each ICO.

ICOs – Part 2 – Investment Returns

Abstract: Although the reliability of the data is limited, in this piece we look at the investment returns one would have achieved by investing in ICOs. We compare the returns against the amount each ICO raised and look at the historic investment performance of the most prolific ICO advisers.

BitMEX SegWit2x Policy

The SegWit2x (B2X) proposal is aimed at increasing the blocksize. It is scheduled to take place in November 2017. This change is incompatible with the current Bitcoin ruleset and therefore a new coin may be created.  

Proponents of this new coin hope it becomes known as Bitcoin, however which coin is known as Bitcoin is not up to the proponents of the new token. Investors and traders may decide which coin has the highest value.  In order for this process to work smoothly, strong two way  transaction replay protection is necessary.

It is our understanding that the SegWit2x proposal does not include two way transaction replay protection, enabled by default. Therefore BitMEX will not be able to support SegWit2x.

As such, BitMEX will not support the distribution of B2X, nor will BitMEX be liable for any B2X sent to us.  This policy applies even if the SegWit2x chain has the majority hashrate. Therefore, it is up to our users to withdraw their Bitcoin's from BitMEX prior to the fork if they wish to access B2X.

BitMEX considers any and all contentious hardfork tokens as altcoins. The .BXBT and .BXBTJPY indices will remain unchanged and will not include B2X.

Full Statement: Policy on Bitcoin Hardforks (Update) and SegWit2x (B2X)

Trading ShitCoin2x

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The underlying index for BitMEX futures and swaps contracts on Bitcoin / USD and Bitcoin / JPY will not include the SegWit2x coin (B2X). Theoretically the futures and swaps should trade at a discount to reflect the B2X dividend received by all holders of Bitcoin on the ex-date. My trading thesis is that similar to the Bitcoin Cash hard fork, the futures and swaps will behave as expected.

Savvy and unemotional traders made significant profits without taking any price risk by taking advantage of the market dislocations. The following trade ideas will focus on the XBT/USD spot market, the XBTUSD swap, and the XBTZ17 futures contract.
 

Trades Pre-Fork

Given the market knows that BitMEX will not adjust the underlying indices, XBTZ17’s basis will trade lower to reflect the implied value of B2X. Thankfully due the current bull market, XBTZ17 trades at a positive basis. This is a perfect entry point for the following trade.

Sell XBTZ17 vs. Buy spot Bitcoin

A few exchanges (Coinbase & Bitfinex) have already announced that they will disperse B2X to all holders of Bitcoin on the ex-date in a 1:1 ratio. Therefore, once the spread is put on, the physical Bitcoin purchased as a hedge should be sent to any exchange that will split the coins for you. This allows you to sell any B2X received immediately. He who sells first, sells best.

On the ex-date (expected to be on or around November 20th), you will receive B2X in a 1:1 ratio. These B2X coins should be immediately sold for USD. At the same time, the futures should trade at a discount or negative basis. The short futures position must covered, and the physical Bitcoin hedge sold as well for USD.
 

Initial Trade:

Short XBTZ17
Long XBT

At Fork Time:

Receive B2X

Trade Unwind Proceedure:

Close XBTZ17, by buying
Sell XBT
Sell B2X

Trade Profit and Loss

Because you were able to enter the futures vs. spot trade at a positive basis, the B2X you sold is pure profit. Also, because you were able to cover the futures contracts at negative basis you will pick up additional basis related profit.

If the futures are trading at a discount when you entered the spread, then you must predict whether the percentage discount is less than the expected B2X / Bitcoin ratio. Or you must have a longer term positive view on the value of B2X.

What Can Go Wrong

If you entered the futures vs. spot trade at a positive basis and the fork does not occur, you will still profit. However, you will be required to hold the spread until expiry in late December. Depending on your hurdle rate, this opportunity cost may outweigh the basis profit received.

If you entered the futures vs. spot trade at a negative basis and the fork does not occur, you will post a loss in the amount of the negative basis.

When you unwind the futures vs. spot spread, the futures contract might trade at a large positive basis. If this happens, you must hold the spread until expiry. The only thing you lose is opportunity cost on the capital tied up in the position.

Right Before and During the Fork Trades

In the hours preceding the Bitcoin Cash fork, the XBTUSD swap traded at a large discount, and the funding was negative. A negative funding rate means that shorts pay longs. This discount is due to traders selling XBTUSD vs. buying Bitcoin spot right before the ex-date so they can “create” B2X without any price risk.

Or traders fearful of negative consequences for Bitcoin due the hard fork are locking in the USD value of their physical coins. The XBTZ17 futures contract will also be sold such that it exhibits a negative basis as well.

Traders may earn the B2X USD value synthetically by taking these countertrades.

Buy XBTUSD vs. Short Bitcoin spot

Profit is earned two ways. Firstly, XBTUSD’s basis will swing from negative to flat in the hours after the fork. Your are long the basis, therefore you profit. Secondly, the funding rate is negative. You will earn Bitcoin interest ever 8 hours while the rate is negative.

Buy XBTZ17 vs. Short Bitcoin spot

XBTZ17 should trade with a negative basis as well. Traders can purchase the futures contract, and sell it hours after the ex-date once the basis rebounds.

The one wrinkle to these trades is where to short Bitcoin spot. This is a very important consideration. If the exchange where you short Bitcoin forces shorts to deliver B2X, then the trade should not be put on. Additionally, borrow rates for Bitcoin will spike shortly before the ex-date. It is entirely possible that borrow fees eclipse the basis and funding profit earned on the long XBTUSD position.

Most exchanges that offer margin trading will not force shorts to deliver or cover B2X. Forcing a large number of shorts to cover in the illiquid B2X spot market could be disastrous. Therefore, most exchanges will not credit Bitcoin lenders with B2X or force Bitcoin shorts to deliver B2X.

Smell That?

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The putrid smell of Bitcoin shorts’ carcasses just became more pungent. The Bitcoin price pump from below $3,000 to almost $6,000 in under one month is truly astounding.

In that span of time China shut down three of the world’s largest exchanges. The New York Agreement signatories proceeded further with the scheduled SegWit2x hard fork. And heads of large banking institutions called Bitcoin a fraud.

Where to from here? How high can Bitcoin go? Is this just a flash of greatness to be followed by a century of misery?

The clues to the future of Bitcoin lie in the global currency and debt markets. The money printing orgy that allows central banks to monetise the debt of governments and large corporates created the environment for Bitcoin to thrive. Therefore, an examination of the total stock of money and government debt could give clues to the future price of Bitcoin.

From Investopedia:

M2 is a measure of the money supply that includes all elements of M1 as well as "near money." M1 includes cash and checking deposits, while near money refers to savings deposits, money market securities, mutual funds and other time deposits.

The government debt statistics are in USD billions were obtained from a Bank of International Settlements report. The data is as of 30 June 2017.

Money is not just M2, but in our financialised world, sovereign-credit acts as a very important monetary instrument. It is why many economists label the currency system a debt-based monetary system.

Other debt instruments such as corporate debt, provincial or municipal debt also function as money. Each country is different in the ways in which other types of debt function as money. To remain consistent I only considered government issued debt.

Gold (XAU) is the analogue “I don’t trust the government” monetary instrument. Bitcoin (XBT) appears to be the digital version. For gold and Bitcoin I used the current value of the total supply of each currency as its M2 value. For government debt, each has a value of 0.

58d64af1-7099-4f28-977a-44f124215c33.png

The above chart depicts the relative size of M2 + Government Debt for the four most important fiat currencies (USD, EUR, JPY, and CNY), Gold, and Bitcoin. The first salient observation is that Bitcoin’s market value barely registers on the graph vs. these larger currencies.

Debt must be paid back at some point with base money, M2. Therefore the more debt a country has vs. it’s base money, the more leveraged their financial system. Governments usually don’t worry about how debt will be repaid because they can continue to issue new debt to pay off old.

However, when the market refuses to roll over debt an affordable interest rate, debt must be extinguished. One theory of how overly indebted governments could reduce the Debt / M2 leverage ratio is to tender debt-backed money at higher and higher prices for real money such as gold. Paul Brodsky in Apropos of Everything I, II, and III lays out an excellent argument for why central banks would extinguish debt-money vs. gold. I don’t believe it is likely that central banks will add Bitcoin to their pool of assets. The more likely scenario is that inflation sensitive investors will tender their debt-money for a relatively cheap real digital monetary instrument such as Bitcoin.

The only reason Bitcoin deserves treatment in is this thought experiment is that against all odds, it is still here after 9 years. The price after falling 80% from 2013 highs to 2015 lows, is now almost 5x higher than the previous 2013 all time high. The other positive aspect is that after years of ignoring Bitcoin, many financial institutions are investigating how they can play the game.

The aggregate amount of government debt outstanding for the four fiat currencies listed is $38,334 billion. At current prices, gold and Bitcoin are worth 20% and 0.25% of the aggregate government debt respectively.

If Bitcoin is digital gold, than theoretically it could reach the same ratio as gold relative to aggregate government debt. That implies a Bitcoin price of $461,333 or an 80x increase in price.

Modesty is a virtue. Assume that Bitcoin achieves a 1% valuation relative to aggregate government debt. That results in a price of $23,065 or a 4x return from current levels.

The battle for $10,000 is one of perception. Bitcoin is still not very useful as a pure monetary transaction instrument given its price volatility. However as a store of value, if savers view it as a hard form of digital money, they will diversify out of debt-money into Bitcoin. This psychological transformation is underway. The longer the price stays at these levels, the more people will believe Bitcoin will exist decades in the future.

Risk Disclaimer

BitMEX is not a licensed financial advisor. The information presented in this newsletter is an opinion, and is not purported to be fact. Bitcoin is a volatile instrument and can move quickly in any direction. BitMEX is not responsible for any trading loss incurred by following this advice.

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