Hi all!
It’s been a packed week, and pixels were positively humming in the newsroom. The drama around Libra continues to perplex and surprise; securities regulators have been busy; and you’ll notice more activity in crypto-gold products. I'm sure it's just a coincidence.
In THE BRIEFING, I take a look at the difficulty of and futility in comparing derivative volumes to spot volumes in the crypto markets. We talk more about crypto derivatives in our new report on the sector – "Crypto Derivatives: What To Expect in a Fast Changing Market" – which you can download for free here.
There’s less than a month to go until our institutional investor event Invest: NYC in New York on November 12th. You can see our main stage agenda and speakers here – and check in as we post updates and more information about side events. Do come – it would be great to say hi!
And next week, we’ll have information about an upcoming CoinDesk webinar… stay tuned!
Until then, read on…
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Crypto derivatives: misleading measurement
Data is useful. It enables us to simplify complex concepts into easy-to-visualize numbers, especially when we can apply shapes and colors and transform them into charts that tell a story.
Such as this one, comparing the size of the crypto derivatives market to that of the spot market:
The story is that crypto derivatives are booming, which points to increasing market sophistication and liquidity.
Yet even data with the best intentions can be confusing and misleading. Derivative volumes are almost always expressed in notional terms – in the chart above, we are not comparing like with like.
Notional volume represents the market value of the underlying asset that the derivative contract gives exposure to. It does not indicate how much was paid up front for the contract; it shows how much of an asset the derivative theoretically represents.
This is one of the main advantages of trading crypto derivatives vs the underlying asset – you can get exposure to a much greater amount that what you put in.
Spot market volumes, however, show how much was actually paid for the underlying assets. Leverage and credit in spot purchases are offered by a handful of venues, but it is not yet an established feature (few exchanges have the requisite balance sheets).
So, when comparing spot volumes to notional derivative volumes, we are comparing theoretical exposure to actual exposure. You’re starting to see the problem?
Future tense
But what’s the big deal? Doesn’t theoretical exposure represent actual exposure?
No, it doesn’t.
First, most crypto futures in the market today are cash-settled. They involve a promise to pay a stipulated price on a specified date, but no actual crypto assets are involved in the transaction. The exposure is financial, not “real,” and comparing these instruments to actual transactions in an asset is misleading.
Second, even with physically delivered contracts, most traders do not hang on to their positions until maturity. It is relatively easy for options holders to either sell their contract or let it expire without exercising, and even physical futures holders are likely to offset their positions before expiry to lock in gains or stem losses.
Third, notional volumes include a lot of double counting. When a futures trader decides to close her position, she will buy or sell an offsetting contract. Her position now nets to zero, but the notional includes the underlying exposure from her two contracts.
Fourth, comparing derivatives volumes to spot volumes is comparing the future to the present. Derivatives are bets on the future; the state of the spot market is a statement about present value. Comparing different time frames is meaningless. Of course there is much more future than present.
And fifth, notional volume does not give a reliable measure for overall risk exposure. It is an accounting construct that lumps together derivatives with a wide range of maturities; short-term has arguably much less risk than longer-term.
Furthermore, the statistic often includes various types of derivatives, with different exposure characteristics. A futures contract implies the obligation to buy bitcoin at a later date; the exposure is in the future. Options, on the other hand, give the holder the right to buy, but not the obligation; the actual exposure is in the up-front payment.
Options open
So, what is the solution?
Unfortunately, there isn’t an obvious one in sight.
The “notional” debate is not a problem specific to crypto markets. Former CFTC Chairman Chris Giancarlo has often spoken about the dangers of relying on notional volumes to form policy, and the CFTC has started looking at alternative calculations.
The task is mammoth, though. In fragmented markets, collating information gathered with uniform standards is tough. This is compounded by the varying margin rules across an asset, and even within an exchange. Throw in the growing use of credit on top of leverage (where the exchange lends you the money for the initial margin), and the actual exposure gets buried even deeper.
What’s more, as credit seeps into the spot markets, the situation will get even more confusing. Some exchanges offer investors the chance to buy bitcoin with a loan, a practice that is likely to grow – in spite of the business risk – since it is an attractive feature for users. Whether this counts as actual exposure or leveraged exposure depends on the rules of the exchange, as well as on your philosophical interpretation of what debt actually is.
While this would be beneficial to trading volumes (who doesn’t want more upside exposure for the same outlay?), it will obfuscate even further the actual state of the markets. Regulators will struggle to understand where risk might be accumulating, and the lack of insight could lead to poor policy decisions.
This is ironic, for an asset that promises enhanced transparency compared to traditional alternatives.
Foreseeable future
The situation highlights the need for more granular information sharing, and for reporting standards. More detailed and useful data will not only enable regulators to get comfortable with the risk in the crypto markets; it will also help market infrastructure businesses with their strategy and product decisions. It could even provide a more useful barometer of sentiment, which would inform investment strategies and lead to a more efficient market.
But even more importantly, the confusion reminds us that we need to question the data we are using, and ask what it is trying to tell us. Often the story is more complex than it seems, and – especially in such a young market as crypto – almost always more interesting.
– Noelle Acheson
Download our new report – “Crypto Derivatives: What to expect in a fast-changing market”. |
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* six especially interesting entries - I'm all about saving you time, but do at least skim the rest.
BIG IDEAS
*These Types of Indicators Will Help You Organize Your Analysis of Crypto-Assets (intotheblock) – What types of indicators are relevant? Which data sources should you use?
*An Introduction to Bitcoin (Grayscale Investments) – Bitcoin’s background, potential and obstacles.
The Investment Case for Bitcoin (Van Eck) – It’s the low correlation to traditional asset classes, and the asymmetric return profile.
What if (Pantera Capital) – Could blockchain technology be the trigger for a new body of economic theory?
Questions and Considerations for Crypto Custodians (Gemini) – Things to watch out for.
Bitwise Comments On The SEC's Order Regarding The Bitwise Bitcoin ETF Trust (Bitwise) – In the face of the ETF proposal rejection, Bitwise has not lost its optimism, stressing the progress made and acknowledging that innovation in exchange-traded products can take years.
*The 'real' bitcoin market might not be real, and is still prone to manipulation: a look at SEC's rejection letter to Bitwise (The Block, paywall) – The lack of crypto exchange regulation seems to be a big concern, and identifying “fake” exchanges does not mean that their volume won’t influence price discovery.
CFTC Chairman Confirms Ether Cryptocurrency Is a Commodity (CoinDesk) – The CFTC has long viewed bitcoin as a commodity; this is the first official confirmation that they believe ether is, too.
Ryan Sean Adams unpacked the implications of the SEC’s confirmation that ether is not a security: further financialization, and increased market concentration.
MARKETS
*Crypto Derivatives Exchanges: Liquidation Pioneers (Deribit) – How crypto liquidations differ from those in traditional markets, some insight into the May flash crash and a look at derivative exchange insurance funds.
Digital Asset Investment Report (Grayscale) – The asset manager revealed that institutional inflows into its bitcoin investment trust in Q3 were the largest in the firm’s history, more than three times the previous quarter, with over half coming in one week.
The Path to Clean Prices in Crypto (Digital Asset Research, webinar recording) – A deep dive into how crypto pricing works in the current markets, how to spot fake volumes and manipulation, and the importance and challenges of qualitative analysis.
*'The client profile is changing:' Fidelity Digital Assets exec says new players are entering the crypto fold (The Block, paywall) – Christine Sandler, head of sales and marketing, said at an event that the digital platform is seeing strong growth in “global macro” clients, and those with a longer-term profile.
CME Says Bitcoin Futures Gaining Interest From Big Investors (CoinDesk) – The number of open contracts at the end of Q3 2019 was up over 60% from a year earlier.
CME expects big demand for its upcoming bitcoin options from Asian traders and miners (The Block) – Tim McCourt, global head of equity index and alternative investment products at the derivatives exchange, revealed some expectations for the soon-to-launch product in an interview to the South China Morning Post.
Bakkt is looking to beat CME to the punch on options tied to bitcoin (The Block, paywall) – According to sources, the ICE-backed crypto derivatives exchange has been "hyping up" options to market makers for the past few weeks.
DOWNLOAD - There's a lot going on in crypto derivatives these days. Want to get up to speed with where the sector's at? Download our free report here.
Messari’s Jack Purdy tweeted excerpts from their recent report on Initial Exchange Offerings.
Is Bitcoin a Safe Haven Like Gold? These Four Charts Say Not Yet (CoinDesk) – Galen Moore shows that market correlations question the narrative of bitcoin as a safe haven.
Thrill-Seeking Drives Investors to Trade Crypto, Study Finds (CoinDesk) – Apparently, when traders make their first crypto trades, their risk taking in other assets increases.
Jake Chervinsky posits that we are unlikely to see any bitcoin ETF approval during Jay Clayton’s chairmanship of the SEC.
Crypto’s Hidden Institutional Challenge – What You Need to Know Before You Start Trading (TabbFORUM) – Jeremy Drane of Lukka highlights how different crypto markets are from traditional ones, how this can hold back institutional involvement and how services are emerging to fill gaps.
Tiny $217 Options Trade on Bitcoin Blockchain Could Be Wall Street’s Death Knell (CoinDesk) – Analytics firm Skew successfully trialled an S&P500 option that pays out in bitcoin via a smart contract.
Vanguard Developing Blockchain Platform for $6 Trillion Forex Market (CoinDesk) – The mutual fund giant has partnered with blockchain startup Symbiont to develop a trading platform that aims to lower currency trading transaction costs by encouraging peer-to-peer trading.
CRUNCHING NUMBERS
Willy Woo shared a chart of the number of addresses with over 1000BTC, which has seen a steep upward slope since the middle of 2018.
Ryan Todd highlighted some of the problems with using crypto asset Sharpe ratios in portfolio allocation decisions.
Bitcoin’s storage cost (Tamas Blummer) – Estimating mining costs enables us to calculate bitcoin’s “storage” costs, or the costs of dilution to current holders – currently at just over 2%, they will drop sharply with the next halving.
10 Patterns of Centralized Crypto Exchanges Explained Using Machine Learning and Data Visualizations (intotheblock) – How monitoring flows into and out of hot and cold wallets as well as deposit and withdrawal addresses can show how exchanges treat client funds.
PROFILES
Former CFTC chair and 'Crypto Dad' says 2019 is the year to get serious about crypto policy (The Block) – Christopher Giancarlo, former chairman of the CFTC, spoke to The Block about crypto policy, the role of regulators and the what he plans to focus on now.
REGULATORS AT WORK
SEC Rejects Bitwise’s Latest Bitcoin ETF Proposal (CoinDesk) – Apparently NYSE Arca has yet to meet the legal requirements to prevent market manipulation.
IRS Cryptocurrency guidance answers some questions while raising messy new ones (CoinCenter) – The good (fair market value and basis were cleared up, and accounting standards were clarified) and the bad (hard forks are taxable income) of the recent tax guidance.
SECURITY TOKENS
tZERO-Backed Startup Seeks SEC Approval to Launch Security Token Market (CoinDesk) – The Boston Securities and Token Exchange has filed a rule change proposal with the SEC that would allow it to create an automated equity trading platform, with ownership records stored on the ethereum blockchain.
Fatburger And Others Feed $30 Million Into Ethereum For New Bond Offering (Forbes) - FAT Brands, the parent company of franchises such as Fatburger, Bonanza Steakhouse and Ponderosa Steakhouse, is tokenizing a bond offering on the ethereum blockchain, in cooperation with digital securitization platform Cadence.
Security Token Firm Taps German Developer’s $7 Billion Property Pipeline (CoinDesk) – German real estate giant Bauwens has taken a 15% stake in blockchain firm Fundament, and will contribute $7.35 billion-worth of projects to jumpstart its asset tokenization business.
STABLECOINS
(Un)Stablecoins (B2C2) – What with the dependence on fiat, and the doubts about collateralization, it won’t be easy for the stablecoin concept to fulfil its promise.
G7 Evaluates Stablecoins as Risk to Global Financial Stability (CoinDesk) – G20 leaders have previously recognized that crypto assets do not provide a threat to global financial stability, a letter to the group from FSB chair Randal Quarles revealed that a G7 working group is concerned about the potential impact of stablecoins.
LIBRA WATCH
Are the dominoes starting to fall? PayPal’s exit from the Libra Association a couple of weeks ago was followed by a host of exits last week, from Visa, Mastercard, Stripe, eBay, Mercado Pago and Booking Holdings.
U.S. Treasury Secretary Mnuchin said that the payments processors dropped out from the founding council due to money-laundering fears. Adding fuel to the political fire, Gabor Gurbacs shared the letter from two U.S. senators that seems to threaten Libra participants from the payments sector with additional scrutiny.
David Marcus, head of the Libra project, alluded to these threats in an otherwise-upbeat tweet. In response, Nick Szabo, recognized as the “father” of smart contracts, chided him for losing sight of why previous attempts at centralized digital cash failed.
Regulator concerns continue: The U.S. House Financial Services Committee has called Facebook CEO Mark Zuckerberg to testify later this month.
Valdis Dombrovskis, the European Union’s financial services commissioner, said he intends to propose new legislation for cryptocurrencies, particularly Facebook’s Libra stablecoin.
And the Bank of England has finalized a set of principles, including “supervisory oversight”, that Libra must adopt before going live in the U.K.
Wired revealed that, in spite of protestations of its relative insignificance, the social media giant has direct or indirect ties to 15 of the 27 founding members of the Libra Association, according to investigations.
And to compound a not-very-good week, Facebook and Calibra were sued in a NY federal court by Delaware-based fintech company Finco Services, for trademark infringement and “unfair competition” from expropriation of its swirly line logo.
Facebook pressed ahead, though, and officially launched the Libra Association, with 21 members signing the founding charter. It also revealed the board of directors and leadership team.
The presence of non-profits on Libra’s founding membership points to points to a potentially strong use case for the proposed stablecoin: bringing those below the poverty line into the global financial system. To help meet this goal, the group is working on some novel approaches to KYC and identity.
PODCASTS
THE SCOOP: Frank Chaparro chats to Peter Johnson of Jump Capital about the need to improve capital efficiency, centralized vs decentralized solutions, stablecoins and bitcoin as a store-of-value.
ON THE BRINK: Nic Carter and Matt Walsh of Castle Island Ventures chat to Hunter Horsley of Bitwise Asset Management about the current level of investor interest in crypto assets, market surveillance, the ETF process and outlook, and much more.
BASE LAYER: David Nage talks to Thomas Chippas, CEO of ErisX, about crypto market structure, stablecoin applications, listing criteria and the evolution of custody solutions.
VENTURE COINIST: Travis Kling and Hans Hauge of Ikigai Fund talk about crypto metrics and quantitative research.
STEPHAN LIVERA PODCAST: Stephan chats to Gene Epstein, director of the Soho Forum, about the intersections between bitcoin and Austrian economics, and the evolving insight into money.
BLOCKCRUNCH: Jason Choi interviews Haseeb Qureshi of Dragonfly Capital Partners on crypto use cases.
A-HA!
*Three Big Things: The Most Important Forces Shaping the World (Morgan Housel) – An epic piece that looks at demographics, inequality, and information access, three inexorable shifts triggering the forces of economic change.
The China Cultural Clash (Stratechery) – How China is weaponizing tech through censorship.
Steve Forbes on the Market, Policy, and the Evolution of Media (Ark Invest, podcast) – Ark Invest CEO Cathie Wood and analyst James Wang talk to the Chairman and Editor in Chief of Forbes Media Group about what we’re getting wrong about interest rates, politics, the evolution of media and bitcoin. An engrossing listen. (Favorite quote: “Bitcoin is a high-tech cry for help.”)
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FIRMS & PRODUCTS
Crypto OTC firm B2C2 has launched a gold derivatives product that allows investors to physically settle synthetic trades with bitcoin.
Digital asset manager CoinShares, working with wallet provider Blockchain and commodity trader MKS, has launched a bitcoin-based blockchain for trading tokens representing physical gold (DGLD).
InfiniGold has launched the Perth Mint Gold Token (PMGT), based on ethereum and backed 100% by gold certificates guaranteed by the Government of Western Australia.
Grayscale Investments has received approval to list its Digital Large Cap Fund, which tracks a selection of digital currencies, on OTC markets.
Crypto product provider Amun has listed on the Swiss stock exchange an ETP based on Binance’s token, BNB.
Crypto exchange Coinbase has been granted an e-money license by the Central Bank of Ireland, which will allow it continue to serve European customers should the UK leave the EU.
Crypto accounting and data processing firm Lukka has partnered with fund administrator Theorem Fund Services to provide same-day net asset value reporting capabilities to digital assets index fund Hashdex.
Crypto exchange Bitstamp, one of the earliest global exchanges, will transfer its assets under management to BitGo for custody.
BitGo now offers staking services, after the acquisition of staking infrastructure provider Hedge.
Crypto exchange LXDX is halting trading effective October 31.
PEOPLE
Nivaura, a London-based regulated fintech startup backed by the London Stock Exchange Group, has hired Chris Jones, formerly a senior executive at HSBC.
Exchange-traded product issuer Amun has hired Laurent Kssis, the former CEO of primary competitor XBT Provider, as its managing director.
Have a tip? Drop me a line at noelle@coindesk.com. |
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Our annual Invest: NYC is fast approaching. On November 12th, at the Marriott Marquis in New York City, you can hear institutional investors, infrastructure builders and sector participants discuss the trends in and outlook for crypto markets.
This year will focus on bitcoin’s role in institutional portfolios in an environment where macro indicators are telling conflicting stories and uncertainty seems to be the new normal.
Come join us! It would be great to say hi.
CRYPTO WEBINARS
Crypto podcasts have long been a staple of market education (see links above, for example), but I’ve noticed that there is a growing stable of informative webinars out there that don’t get enough air time in my opinion.
Here you have the crypto market webinars that I know about and that I think you might find interesting. If you’d like your webinar listed here, let me know at noelle@coindesk.com (no guarantee of inclusion, though).
Crypto Market Data 101 – Nomics - Every weekday, 3pm ET
Analyzing Social Media For Crypto Assets: Myths Vs. Realities – IntoTheBlock – October 23, 12pm ET
Distributed Systems, the Fintech Revolution and the Public Sector – Global Digital Finance (GDF) - October 29, 8am ET
We have a NEW REPORT for you! This time we look at the complex world of crypto derivatives - the who, why, what and where. You can download the report for free here.
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Institutional Crypto - Derivatives and misleading measurement