15: Arthur Hayes — The Wild West of Crypto Futures

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Arthur Hayes, co-founder and CEO of BitMEX

AMLG: On today’s episode we have Arthur Hayes the founder and CEO of BitMEX also known as the Bitcoin Mercantile Exchange a cryptocurrency derivatives exchange. The company offers centrally cleared options and futures based in Bitcoin with up to 100X leverage and is generally considered one of the most secure and liquid derivatives exchanges out there. BitMEX is based in Hong Kong so it’s great to have Arthur here in the flesh in Soho New York with us today, which is always a lot more fun than doing this by phone. Welcome Arthur.

AH: Thanks for having me.

Link to story

AMLG: It’s also a crazy day to be recording this because as I was looking at my tickers and Coinmarketcap this morning Bitcoin has just surpassed $9700, though it depends where you’re checking. But it’s definitely flirting with the $10,000 mark. The latest headline when I walked into the studio was that the total crypto market cap is now over $305 billion which makes crypto more valuable than Bank of America. So we really couldn’t have a more fitting guest today to discuss the crypto markets. I’m sure the listeners at this point are thinking, I don’t even really know what a crypto asset is let alone a crypto derivative. Don’t worry, we’re going to get into all of that. To start let’s get into your story and how you got here. The two of us actually met in Hong Kong in 2009 when I was reporting for the Wall Street Journal there and you were a trader. Tell us about your journey to Hong Kong and to founding BitMEX.

AH: I graduated from university in 2008 and had taken Chinese for two years. However I was not fluent, so I came to Hong Kong instead and did an internship my junior year at Deutsche Bank. I had an amazing time because 2007 was the all time high in the markets. Then the day I joined Lehman in 2008 was the day they went bankrupt, a complete reversal of fortune for the financial industry. I worked for Deutsche Bank for about three years on the exchange traded fund trading desk. I was a market maker on the Hong Kong and Singapore Stock Exchange and also did a bit of index arbitrage across different equity indices in Asia. Then I moved to Citibank to do the same thing. Then in 2013 — which now is very fortunate — I was told to pack my bags and leave.

AMLG: Due to the division shutting?

AH: The CEO cut something like 10,000 jobs and its last in first out and I was the youngest guy on the desk, so obviously I was cut. Then I began my journey to Bitcoin. I heard about it on Zerohedge first in April 2013 when we went to $250 on the Silk Road pump and then the charges were brought against it and it dipped. I read the whitepaper as I now had ample free time to do whatever I wanted and I researched how to trade the thing. I sent my first thousand dollars to Mt Gox and started arbitraging between futures exchanges — called ICbit and 796 — then spot exchange arb as well. That’s basically how I paid my rent for six months.

AMLG: How much were you making when Bitcoin was around $250? The exchanges were not very well established, you were using ICbit — are they still going?

AH: No they shut down around 2015.

AMLG: Did you get the $1000 bucks you sent to Mt Gox back again?

AH: Luckily I was able to get out before they went down. I remember I tried to close an arb out and I sent them a withdraw request, waited two weeks, emailed them asking where my money was. They said “oh we have this really long queue for getting your money back.” I said, well what can I do to speed this up. They said “you can give us 5% of the notional of what you’re withdrawing and we can speed it up.” I thought well that sounds dodgy but at this point 5% is better than zero. So all right I’ll pay.

AMLG: I bet everyone wishes they had made that calculation.

AH: But I still didn’t get the money. I waited in line for another week and then I saw China was at something like a 40% premium so I withdrew my money in Bitcoin from Mt Gox, sold it for renminbi in China, and then walked the money across the border.

AMLG: Physically?

AH: Yes physically. You can walk 20,000 renminbi across the border.

AMLG: Like with iPhones strapped to your body?

AH: No no I was within the legal limit. Me and some friends went over for lunch one day and we all had a brick of cash to bring back with us.

AMLG: To Guangzhou?

AH: To Shenzhen, got on the bus. So I started doing that for a bit and then decided I wanted to do a real business around Bitcoin. I know derivatives and there wasn’t a good offering at the time so I thought I could create a better exchange.

AMLG: What was the community like at that time, when you left Citi were there a lot of people in Hong Kong you could talk to you about crypto? How did you educate yourself — was it all online, were there good meetups, what was the environment?

AH: I don’t think I went to a meetup until 2014. I literally just went on Bitcoin wiki and Reddit, and read about all the different exchanges, opened accounts with as many exchanges as I could. I got hacked, lost Bitcoin, all the things that happened to people. Especially back in 2013 when you really had no idea — you sent a bank wire, you’re freaking out thinking the exchange is going to go down, that they stole your money. Or you put in the wrong character and the bank wire doesn’t arrive and you’re wondering if you’re going to get your money back.

AMLG: How many of these were unforced errors, Arthur accidents, versus exchange security?

AH: I mean you learn crypto common sense. Not that you did anything wrong but you can see why it was easy for someone to steal from you. You learn that quickly after losing tens of thousands of dollars on those sort of errors. But that’s part of the game.

AMLG: So that was the landscape. Then what convinced you to start this company as you were looking across all the things you could do, was it mostly your experience of bad exchange usability and security? But you decided not to do a spot exchange and to focus on derivatives instead, maybe you can explain why you decided to do that.

AH: If you look across the trading floor at a bank the guys and gals who drive the fast cars, have the nice watches and the big houses are not the guys and gals who trade cash products. Meaning buying and selling physical stocks, buying selling Spot FX, buying and selling physical bonds. It’s the people who are selling and trading derivatives on that, because you can put a lot of leverage on it. You can put some non-linear exposures on it. The banks make a disproportionate percentage of their money from the trading of derivatives but not actually trading the physical asset. So as I looked across the exchange landscape at the time I saw a lot of exchanges in the spot game. Even today that’s still extremely profitable. On an absolute revenue basis, spot exchanges are still the top earners.

AMLG: How much do you think they’re making, the big ones?

AH: Anywhere between $1–6 million dollars a day in revenue.

AMLG: For a Bitstamp?

AH: Bitstamp maybe not so much. But if you look at the top Korean exchanges, Bitfinex and some of the Japanese exchanges you can definitely see them easily over the $1 million mark a day — exchange profitability is anywhere between 80 to 95%.

Exchange comparison [Source]

AMLG: And not that hard to run if you build it right.

AH: Correct. People are running them pretty poorly and still making a lot of money, which speaks to the demand out there for this new asset class. But over the long term spot trading is something that easily becomes a commodity. If you look at Spot FX no one makes money trading Spot FX unless you’re a large bank ripping people off hundreds of basis points to do currency transactions at the airport. But the liquid spot market is not where banks make money.

AMLG: And from a regulatory perspective — in terms of getting your license — it’s also harder because you’re actually touching the asset?

AH: Correct. You’re dealing with banks, which is the biggest cost center for any spot exchange, all the operational work around handling other people’s money. You worry about your bank shutting you off because you’re dealing with a high line of wires. You have possible KYC AML lapses that could impact the bank that banks you, which is why they do not like to take Bitcoin and cryptocurrency companies. Then in a 5 to 10 year view, why doesn’t a bank offer this themselves? If they see that a client of theirs is making $100 to $500 million U.S. dollars in revenue a year and they’re the critical component of that exchange, then why don’t I just do that business, if I’m already in a spot FX trading business. Obviously a bank would have to figure out how to do Bitcoin custody and deal with the risks around that. But if you’re making that kind of money you can afford to get hacked a few times.

AMLG: OK its 2014 and you decide a derivatives exchange is the way to go. Tell me about your two co-founders, how did you find them and how did you convince them to do this?

BitMEX founding team — Arthur Hayes, Samuel Reed, Ben Delo

AH: I found them in Hong Kong through various circles. Ben Delo who is the person responsible for our amazing trading engine I found through a mutual colleague. I approached his colleague and said, “hey you want to do a Bitcoin derivatives exchange?” He said, “well I have a wife and kids so not really. But why don’t you go and speak to Ben because he’s really interested in Bitcoin.” So I got in touch with him, met him for a beer at Red Bar, explained the idea. He was like, “Yeah. This sounds like something I would want to do.”

AMLG: Was he leaving a bigger institution to do it?

AH: Yeah. He had worked at various hedge funds and investment banks over his career doing HFT systems. Then for the web and servers side I found Sam Reed who was also CTO of a startup at the time and was a big altcoin trader doing arbitrage on the side. I found him through a mutual contact and I pitched him the idea of a derivatives exchange and was able to convince these guys that this is something we should do. We started building it in January 2014.

AMLG: How long did it take?

AH: We went to a public beta in six months via a trading game. We gave away around $5000 U.S. dollars for people to come on board, trade in a testnet environment and whoever made the most fake Bitcoin got a prize. But it was based on the futures contracts settled on the real world price of Bitcoin. That was a good test, then we did another five months of testing after that and went live in November of 2014.

AMLG: Based on what you’ve said in the past, you initially thought Bitcoin would be adopted by the legacy financial institutions — and perhaps that’s catching up with us now — but at the time you wanted to create a Wall Street type contract with low leverage but you found that the market was actually retail traders who wanted high leverage and wanted to speculate. Tell us about that decision to pivot away from legacy financial institutions to retail investors.

AH: We went live in November 2014. The price of Bitcoin dropped about 50% from that level by January of 2015 and then spent the next eight or nine months between $200 to $300. Very low volatility. It was a tough time to make any money. If you’re offering a low leverage product in an asset that’s fallen about 90% since the high of 2013 and expecting banks and other large financial institutions to get involved — well they were obviously nowhere to be seen. We were doing no volume making no money and spinning our wheels, so we said well there’s a fervent community of retail traders. Let’s build the best casino we can build.

See full bitcoin price history and related events

AMLG: In terms of who’s playing in this futures casino, geographically, tell me more about the current client base. Are they mostly in Asia? Is it Europe as well? To be clear for listeners — BitMEX is not available to U.S. based traders.*

KRW-BTC has grown from 11% volume in August to 18.6% as of 12/06/17 [Source]

AH: About 25% of our volume comes from China and South Korea and then a smattering of European countries. Eastern Europe features prominently in our client list. But really right now it’s the Koreans, they are driving the whole rally across exchanges. They’ve taken to Bitcoin like nothing I’ve ever seen in terms of a country. They have a more open financial system, they have the fastest Internet in the world, the highest percentage of people who are connected to the Internet and the highest percentage of people with smartphones. And they have about two decades of cultural experience dealing with virtual assets starting with gaming goods — swords and spells and skins. South Koreans were trading these for real money decades ago. Culturally they understand digital assets. If you’re moving to digital money it doesn’t take a big leap for them to get involved, which is why they are now driving the whole ecosystem.

The WAX token sale ended Nov 2017 and raised 160k ETH (then ~$80m USD)

AMLG: I always wonder when we talk about killer apps and use cases why there hasn’t been more gaming-related crypto assets and tokens. There’s been a few — the OPSkins guys just did an ICO — but it seems like that would be a natural place to start. What do you think?

AH: It will happen. Tencent owns Supercell and they’re in China so they’re probably not going to add cryptocurrency to their gaming market. But I could definitely see how cryptocurrencies could catch on quickly for Korean and Japanese gamers.

AMLG: Let’s have a look at the BitMEX interface and talk about the user experience. Tell me what we’re seeing. If I am the average client and this is my screen here, what am I looking for. We’ve got the prices going crazy, things are flashing. What is your average trader doing when they log in?

The BitMEX dashboard

AH: The average trader is probably looking for our Bitcoin versus U.S. dollar product because that’s the most liquid product we have. They want to get in and they want to get out. They have a view on which way they think the market is going. They like the fact that we offer high leverage. They’re placing an order, a limit order or a lot of clients now that we’re very liquid can place market orders with a little more safety. If they think the market’s going up they’re going long, if they think the market’s going down they’re going short. They can go both directions it’s not really a long only or long sell only market.

AMLG: And there’s about 15 products on the site.

AH: Yeah. The majority of the volume is our Bitcoin U.S. dollar swap product. Then for the altcoin products Bitcoin Cash and Ethereum are popular.

AMLG: I’ve heard you say in the past the most popular is this 100X leverage perpetual swap product. Can you explain what that is.

The swap cumulative funding rate vs spot price. A swap can be used to earn passive income without taking direction on the bitcoin price.

AH: We started out with purely futures contracts. A futures contract has a definite expiry date which means that after a certain point in time exposure to your underlying asset goes away. The majority of retail Bitcoin traders are technically savvy but have not had that much financial services experience. For them to understand the mechanics of a futures contract is a bigger leap than for a traditional retail investor. What we got were a lot of questions as to what happened to their position.

AMLG: Like why did my futures contract expire?

AH: Exactly. They didn’t understand that, why a futures contracts trades at a different price than the underlying asset.

AMLG: So they’re not super sophisticated.

AH: They’re don’t understand derivatives. What they do understand is margin trading. Usually the evolution of a Bitcoin trader is — they buy their first Bitcoin, they get into the system, then they say I want to go long or short on leverage. So they start trading on a margin trading platform where they’re borrowing somebody else’s usually U.S. dollars or Bitcoin to affect the leverage long or short. That’s an easy product because it trades in the same spot book as if you were buying and selling physical Bitcoin. What we thought was, well why don’t we create a product that never expires and feels like margin trading. But we still have to be completely synthetic, meaning we don’t have physical dollars in Bitcoin moving between longs and shorts. It has to be purely based on a contractual term. What we came up with was a perpetual swap, which essentially is a string of eight-hour futures contracts that roll. That creates an interest rate that’s exchanged between longs and shorts, which keeps the product anchored to the underlying index. If the swap trades at a high premium then long will have to pay interest to shorts, if the swap trades at a large discount then shorts will have to pay interest to longs . And this exchange of interest actually keeps the product pretty closely tracking the underlying spot market. For a novice trader this allows them to feel like they’re trading on margin, which is why this product has become extremely successful and trades something like 10 to 20 times the volume of our futures contract.

AMLG: That’s interesting. So the majority of users are using this product then?

AH: Correct.

AMLG: Are they also margin trading on spot exchanges?

AH: They could depending on the opportunity. But the trading of the swap contract is actually more capital efficient and safer than trading on margin. We require at a minimum 1% down. If you have a 100 Bitcoin position you need to put down one Bitcoin. Let’s say you have 100 Bitcoin and you want to speculate with that. You can only deposit one day with BitMEX, and go long or short Bitcoin depending on your view. But if you want to trade on margin you’re going to have to deposit 30 to 50% of your total Bitcoin stack on an exchange. Obviously there is counter-party risk with exchanges. So all else being equal you’re placing yourself at a bigger risk if your goal is to trade, going in and out of a position, then margin trading places you at a bigger risk of a credit event happening on an exchange. That’s why people do like to trade a higher leveraged product. The second point is that its limited liability. You can’t lose more than you put in. Unlike some FX trading platforms where you can actually owe your broker money and they will sue you to get it.

AMLG: Its sort of a stop order?

AH: Exactly. If I put a one Bitcoin position on with 100X leverage and the price goes against me I know the maximum I can lose is one Bitcoin.

AMLG: When I logged in here all I did was sign up with an e-mail address right. All you need is a verified e-mail address — it’s technically anonymous, I could be anyone? And then what happens, you get a Bitcoin address, you deposit Bitcoin and then you can start trading?

AH: And then you can start trading. And your profit and loss is denominated in Bitcoin as well. You come in with Bitcoin you leave with Bitcoin. We don’t offer any exchange services — if you want to get back to dollars or another fiat currency you need to go to another exchange. If you want to exchange Bitcoin for another cryptocurrency you also need to go to another exchange.

AMLG: What depth of order books are you seeing now?

% share of BTC USD volume, including both spot and futures exchanges [Source: BitMEX]

AH: Our Bitcoin U.S. dollar product is the most liquid trading instrument of any exchange around the world. I think today it did $2 billion U.S. dollars of turnover. Usually it’s between $1–1.5 billion U.S. dollars of turnover on this product. It is extremely liquid and if you want to speculate on the future price of Bitcoin it is the only product you should be trading.

AMLG: That’s one of the reasons why the institutions haven’t been able to get in the space in a meaningful way right — the volumes have not been large enough for the hedgefunds to come in without impacting the market?

AH: That and a lot of them don’t know how to handle Bitcoin. The product is great for somebody who is a U.S. dollar based investor who just wants to trade off Bitcoin volatility. They’re going to have to own Bitcoin. They’re going to have to know how to custody that Bitcoin. They’re going to have to get their auditors and LPs comfortable with the risk that either they could mishandle the security of their Bitcoin, the exchange could get hacked and lose their Bitcoin. These are all risks that a regulated financial institution probably doesn’t have in their charter, which is why to date they have been only able to dip their toes in. It’s mostly on a P.A. basis that they will buy and sell digital currencies.

AMLG: But it does feel like the institutional march is happening — all the smart traders at these shops are doing it personally so it’s only a matter of time till it trickles through, maybe to the prop shops before the big banks?

AH: Yes the prop shops are already involved. They are market making and some of them have OTC desks. They’re involved but usually they trade with a few partners’ money. They don’t have outside capital so they don’t need to worry about all the fiduciary responsibilities of a bank or a large asset manager. They can get involved more quickly than others.

AMLG: I guess what happens next and what I’ve started to see is that the LPs say, well you guys are making money on this, what about us? We want some exposure too. But with that comes solving the custody and security question, which is what I want to ask next. You say you’ve never been hacked which is incredible. Of course you’re not actually storing anything on the site, that’s a part of it — but maybe you can explain the challenges around security?

AH: The number one rule of a big exchange is don’t lose the Bitcoin.

AMLG: It seems like a lot of exchanges haven’t followed that rule.

AH: Easier said than done. What’s lucky about being a trading platform as opposed to somewhere where people buy and store assets is that if you’re just trading then you don’t expect your money back immediately. If I deposit 100 U.S. dollars on Coinbase and buy Bitcoin, most times I’m going to want my money immediately, I’m going to try to withdraw my Bitcoin immediately. Coinbase and other similar exchanges have to operate what’s called a hot wallet, meaning that a server has to automatically approve withdrawals if you correctly authenticate yourself. Which means there’s no human oversight, it’s an automated process. That is a goldmine for hackers. It means there is a process where no humans have any oversight that’s purely based on technology that is accessible to the Internet. I want to hack that all day long. And that is where the majority of incidents happen, with an exchange’s hot wallet being compromised.

We see this and we also know that our clients have no expectation of their money back immediately, so what we said was we’ll only offer withdrawals once per day. It will be a completely manual process and we’ll use what’s called a multi-signature wallet, meaning that a certain percentage of keys need to sign off on every withdrawal. Number one we don’t have as many clients as many of the other spot exchanges because we deal with only traders. We weed out a lot of people who possibly could have an account — because number one you have to own Bitcoin and number two be comfortable enough to send this Bitcoin from somewhere else to BitMEX. Those two steps limit the number of people who ever open an account with BitMEX. We’re OK with that because our clients are the most profitable clients and we don’t have people that we spent effort getting onto the platform buying crypto assets, leaving it there and only paying us once.

AMLG: So they’re more the whales than the minnows?

AH: Not whales. They trade — they turn their book. They’re there to go in and out of positions not to buy a crypto asset and have me do all the work of storing it for them. That way we have less money than other people, we don’t have a hot wallet and we have a manual process with an intense amount of oversight, which makes the attack surface area much smaller for BitMEX — and touch wood we have not been hacked so far.

AMLG: Just so the listeners can understand what this means — you have no hot wallet meaning you’re doing cold storage, and you do withdrawals once per day with M of N security, multi-signature. Two out of three of your co-founders need to authenticate a transaction to withdraw funds?

AH: I can’t give specifics as to how the authentication happens, but in a general sense that is the process. That means that every day at 1300 UTC if you submitted a withdrawal in the past 24 hours it will be included in that batch and shortly afterwards you’ll receive any Bitcoin that you’ve withdrawn.

AMLG: Does that mean you have to run to a vault once a day?

AH: No we don’t we don’t have to run to a vault.

AMLG: Because I looked at a storage company a few years ago — they advertised that they had running trainers on so they could run to the vault and do the cold storage, across three different states…

AH: I doubt that any exchanges have runners to vaults anywhere.

AMLG: OK. But your office is anonymous right, your location isn’t posted. Things like that?

AH: I mean you can come visit us in Hong Kong. We’ll tell you where we are but we don’t post our office address publicly on our website. Not to say that if you came to our office with a gun you could actually get any Bitcoin, you couldn’t. It’s one of those things where physically attacking an office is not going to get you any funds.

AMLG: Good to know. So you’re able to sleep at night.

AH: Exactly. I know that while I’m asleep there are no Bitcoin leaving my exchange.

AMLG: That’s more than others can say. Maybe then you can talk about what does keep you up at night? Are there other challenges that are top of mind?

Monthly volume of the largest crypto exchanges BTC/USD

AH: Well any exchange is only successful as long as they are liquid. It’s 2017 and BitMEX and all the other large exchanges had amazing years this year. But the road isn’t over. There still is a large possibility that someone could come out of nowhere and attract a large amount of liquidity from our target client base. What keeps me up at night is how do we grow faster and faster. Right now we account for something like 60 or 70% of trading volume on Bitcoin U.S. dollar globally. I want that to be 99%. I want there to be no question that we are the most liquid exchange, that if you’re going to trade Bitcoin or any other digital asset then we are the place to go and no one else should try to challenge us in the derivatives space.

“We’ve seen pent-up demand by clients. Bitcoin is a story that hasn’t gone away and we’re constantly getting calls about how we’re going to list this product,” CME CEO Terry Duffy 10/31/17. [See: Bloomberg video]

AMLG: Let’s get to that — the competition side. I’m sure you’ve been bombarded because of the news over the last month. You were one of the first real players in this space, but we’ve now had both the Chicago Board Options Exchange (CBOE) and the Chicago Mercantile Exchange (CME) announce last month that they would launch Bitcoin futures by the end of the year, pending regulatory review — asterisk because these are U.S. based entities. They also released the specs of the futures contracts — they will be cash settled according to the daily settlement price of the Bitcoin Reference Rate (BRR) which like yours tracks a few major Bitcoin exchanges. So we’ve got these well-known players coming into the space. But they have quite a different approach and probably a different client base than you right?

AH: Absolutely. The CME contract, which I think is scheduled to launch on the 11th of December, will give large institutions who do not want to deal with handling Bitcoin the ability to speculate and capture some of this Bitcoin volatility.

AMLG: The handling part being the fact that it’s cash settled?

AH: Cash settled in U.S. dollars. Yes and even the CME doesbn’t have to touch Bitcoin. If you look at the specs of this product it didn’t change anything. All they did was replace S&P 500 with Bitcoin vs USD, created an index with CryptoFacilities and launched a product. That’s why they were able to get a product out before the end of the year without having to get additional approvals — because they actually haven’t changed the fundamental nature of their futures exchange, which has big issues with regards to the way Bitcoin trades.

AMLG: One thing that confuses me and I was reading a great piece by Matt Levine the Bloomberg columnist on this — if you buy an oil futures contract on the CME and you hold it, when it expires then someone actually hands you a thousand barrels of oil. But if you buy and hold a Bitcoin futures contract when it expires nobody is handing you the five Bitcoins. What I can’t understand is, if you’re buying Bitcoin futures you’re probably doing that because you think Bitcoin will go up. You have some fundamental belief in Bitcoin or whatever the crypto asset might be. If you think it’s going to go up it’s probably because you think it’s going to be more widely adopted — a good store of value or an alternative to the current financial system. But if you thought that why wouldn’t you just buy and hold Bitcoin? His argument is that you’re buying the futures because deep down you actually prefer the existing system. And obviously there’s the risk aspect of actually holding it. But do you agree with that, that people are trying to get the exposure without holding any crypto? This gets to true believers versus not true believers.

AH: A large financial institution shouldn’t be true believers in any asset. An asset is a price and a volatility and a correlation with other assets. Bitcoin is negatively correlated with most assets, has high volatility and has been one of the best performing assets of human history. A financial manager has to consider this in a universe of assets. He or she does not have to have a view as to whether or not it is a sustainable asset class, it doesn’t matter if you’re trading a one month futures contract or a six month futures contract. Will Bitcoin be above zero six months from now? Probably. It could be close to zero but it will probably be above zero. I don’t think that a trader needs to believe in Bitcoin or Ether or even has to believe in the S&P 500 — it doesn’t matter. It’s a price a volatility and a correlation at the end of the day.

AMLG: And you make money whether it goes up or down.

AH: Absolutely.

AMLG: A lot of people when they start playing around in crypto and make a bit money, they then think well maybe I should read into this. Then they start studying it and often become true believers once they understand the implications while also realizing they can make money. Where would you put yourself on that spectrum. Are you interested in the underlying technology, the social revolution and all the philosophical battles or do you try and stay clear of that?

AH: I do believe in the financial privacy aspect of cryptocurrencies. I don’t know which currency is going to succeed. I think there’s going to be winners in each vertical. You’ll have the anonymous coin, you’ll have the coins trying to be money, you’ll have stablecoins, protocol coins and decentralized computer coins. There’s all these different value propositions for a token or a cryptocurrency. I believe we have a whole new way of sending value between computers, and a whole new way of dealing with privacy issues. We also have a movement by governments who want to own every piece of financial data that we produce. I don’t see a scenario where that’s not going to happen. I think every financial transaction in a fiat currency will be monitored by every central bank within the next decade and anyone who thinks that physical cash will be around — in the absence of a nuclear blowup or civilization not having electricity — is being very naive. So I am long on financial privacy being a big concern for a large percentage of the population and that ultimately means they’re going to have to turn to a cryptocurrency. I don’t know which one that will be. I’ve built BitMEX to be agnostic in terms of what will succeed. We’re just taking a bet on cryptocurrencies as an industry.

AMLG: That suggests that you think there is some underlying value right. Even if we’re in a bubble and it corrects, that there is a real value there — maybe like the Internet bubble or the railroad bubble things popped and came down but there was real building and value that continued.

AH: Absolutely. There’s real value in privacy. Humans value privacy and there will be a large amount of wealth created in enabling people from all across the world to do financial transactions without someone looking over their shoulder.

Full Ethereum price history. What do you think one Ether should be worth?

AMLG: One of the other valuation models that people have applied derives from the value of the network. Say we take Bitcoin as gold, or take Ether which people compare to fuel. I wonder what you think of this basic way of valuing or is it nonsense: if Ether is like fuel and you need a bit of that fuel for transactions to be processed on the network, then you could derive a value for Ether based on how many transactions will get done — say in five years, how many transactions are getting done on the Ethereum network. Multiply that by however much fuel is required and then the market cap could be the net present value of the discounted cash flows of that network. Do you think that’s one way of deriving a true value?

AH: I think it’s an exercise in futility to derive a true value for any of these currencies. Let’s say you thought the true value of a Bitcoin was $10,000 today and it declined by 75% in the next five minutes. Now how strong of a conviction are you? Probably not strong. 99% of all traders will have sold that position. It’s nice to have a model but when the market starts slapping you in the face with massive losses you’re going to change real quick. People need to look at this on more of a time horizon. I have a time horizon — this is the level where I think it makes sense to own, this is the level where I think it makes sense to sell—take a more nuanced approach. That being said if you were somebody who bought Bitcoin at several hundred dollars or even a few pennies years ago, that takes a lot of mental conviction to hold a position that long in the face of a lot of uncertainty.

AMLG: They say Joe Lubin still hasn’t sold any of his Ether right.

AH: Exactly. It points to the fact I’m not a fundamental investor. I’m a trader at the end of the day. I trade things I don’t invest in things.

AMLG: Do you think that futures markets and what the CBOE and CME are about to do will help the ecosystem and smooth out volatility?

AH: Initially, because of the way these contracts are structured, they will actually increase the volatility of Bitcoin.

AMLG: How does that work?

AH: Let’s take an example — the CME contract is closed over the weekend. So the price closes on Friday and reopens Sunday night just like any Globex futures contract. And it has a 20% upper limit and down limit, meaning the contract over a 24 hour period cannot trade 20% above or 20% below where it closed Friday at London 4pm time. Let’s take the Bitcoin Cash situation, the price of Bitcoin dumps 30% between Friday and Sunday. The CME contract opens limit down, so no one can trade. From the exchanges’ point of view you could possibly have a situation where you immediately open the exchange and a certain subset of traders are instantly liquidated because they don’t have enough collateral to cover the loss on that contract. This is a volatile event especially if the CME attracts significant open interest on their product. You could see interesting things happening on the spot and physical markets. You also have the fact that half of the exchanges in their index are extremely illiquid and have technical problems with handling even today’s load on their exchanges. You could see a situation where a malicious actor would DDOS the exchange and move the price before one of the settlement periods to affect how the futures contract trades or how brokers have to liquidate some clients. It’s going to be interesting to see.

AMLG: Sounds like a scary short-term future.

AH: It’s the market. It’s Bitcoin. People have been lulled into complacency with a market that keeps going up every day. They don’t understand that this is an extremely volatile asset. It’s not constrained by national borders and there are people out to do whatever they can to make money, including nefarious things against exchanges.

AMLG: They’re going to have a lot to handle when they get into this in two weeks, it will be interesting to watch. Another product we haven’t talked about is ICOs and tokens. You’ve said it’s useful to have derivatives for tokens because of market discovery and that it helps smooth out expectations when you have a blackout period. Can you explain your activity in the token markets and how you think it’s helpful?

AH: We don’t engage in subscriptions to ICOs. You can’t purchase an ICO on our platform, we don’t promote ICOs we don’t advise on ICOs. What we do do on certain occasions for large and controversial ICOs is we’ll launch a futures market.

AMLG: What would be a large and controversial ICO?

AH: Tezos. We launched a Tezzie versus Bitcoin futures contract that expires at the end of December. There’s a lot of uncertainty around ICOs. The biggest uncertainty is will they actually build the thing and list the token in a secondary market? You’ve paid your hard-earned Bitcoin or Ether for an allocation of this deal and you need to wait for the team to launch that and actually give you a token. There’s a lot of uncertainty around that. And are they actually going to deliver on the technical merits of what they said in the white paper? If they do actually launch this thing is everyone going to dump it immediately because they thought the team didn’t really deliver on anything that they say they can deliver on. What we do is for the period between when an ICO completes its token generation event and when it lists on a secondary market, give some indication as as to what the market believes the true value of the token is.

AMLG: Where is USD Tezzie trading now?

AH: Part of the terms of our contracts for ICOs when we don’t know whether or not they’re actually going to list on mainnet is that if the ICO is not listed — on that contract it’s either Poloniex Kraken or Bittrex — 24 hours preceding settlement date, then the contract will be settled based on the ICO price. What happened when the article in Reuters came out which alluded to the fact that they were not going to finish on time and it should happen sometime next year when they will release Tezzies, the market crashed something like 75% down to the ICO price. Right now that contract trades at the ICO price where theoretically it should because by the terms of the contract people will only receive that value as of the ICO price rather than whatever the market thought it would be worth by the settlement date.

AMLG: There was a lot of hunger for the Tezos ICO. It was one of the earlier ones in the ICO boom. How do you pick? You’ve referred to it as being a “hot or not” process. You want the controversial ones, you want the big ones, you want the scammy ones so people can short them. Do you support the Paris Hilton and Floyd Mayweather tokens? Jesus Coin?

AH: They need to have raised over a hundred million dollars and I need to believe that they can hit a one billion dollar market cap fairly quickly. Then we need to have traders talking about it. At the end of the day we are beholden to our traders. If our traders aren’t talking about it, if there’s not chatter — “Did you see how ridiculous that ICO was? Did you see how much money they raised? Did you see how shitty their whitepaper was?” I want to hear that.

AMLG: Where are these conversations, WeChat?

ICO banter in WeChat forums: “IOT Chain— buy buy buy” I got out of YoYow in Sept. But today it increased like 20x, but I have no regrets lolz” [Courtesy TLDR Capital]

AH: WeChat groups, Telegram, Reddit comments. We want to get the zeitgeist of the traders. What are they feeling, how elated or despondent are they about a particular ICO. That’s what I want to list. I get hundreds of proposals for ICOs and I don’t even open most of them because if you have to send me an e-mail to talk about your ICO is not worth shit.

AMLG: Right if they have to market to you its a bad sign. Its like Groucho Marx applied to ICOs, I wouldn’t want to be in any ICO club that would have me as a member. I’m in a few Telegram conversations and other Facebook Messenger chats that discuss upcoming ICOs— its pretty overwhelming. I wake up in the morning and there’s hundreds of new messages in each chat. They blow up 24/7 especially because the communities are also international. How do you sort through the noise and find which ones are valuable?

AH: I have a few traders and KOLs that I’ll ping about an ICO and say hot or not and they’ll tell me real quick.

AMLG: Do you ask in Chinese. Reh or leng?

AH: Ha. I’ll also ask some of our salespeople what people are talking about in these country channels. Sometimes we’ll think about an ICO like — we want to be big in Korea. What do the Koreans care about? That’s a product we should list. It all ties back to what is going to generate chatter about BitMEX, what is going to generate trader interest, what is going to keep them on the platform. They might not trade that much of this ICO futures contract but they will stick around and trade Bitcoin U.S. dollar 100X.

AMLG: And the profit and losses for token trading are also in Bitcoin, everything is in Bitcoin?

AH: Correct.

AMLG: Given that so much of the ICO market is funded by Ether would you consider taking Ether as collateral?

AH: We’re actually looking at expanding BitMEX to take other forms of crypto collateral and we are actively looking at how to accept Ether as collateral. Hopefully depending on our ability to make some progress on our wallet software we can offer EthMex sometime in 2018.

AMLG: I look forward to seeing that. Changing tack for a second, since you’re here from Asia and it’s interesting to talk to anyone who has insight into Asia — I want your perspective on China. In September they banned mainland residents from trading on crypto exchanges. They made it illegal for startups to raise funds via ICOs. Bitcoin prices fell, Ether prices fell and then ultimately everyone just shook it off. It was like the crypto markets were punched in the face and then everyone realized well, ultimately blockchain and crypto are still decentralized and autonomous and that Chinese crypto companies can just up and shift to other places. Are you seeing that, companies relocating out of China? What changes have you seen?

AH: The large Chinese exchanges are all refocusing their efforts to crypto only exchanges and mostly they’re moving down to Hong Kong. To base their operations away from Beijing. That’s not to say that they won’t reopen in China later. Everyone sort of assumed that China will follow the similar playbook that they follow with every other new industry. They let there be intense competition for a while. They see who the winners are. They shut it off for a bit and then they reopen it with explicit control of everything and the companies that they’ve approved to do business.

AMLG: Right they don’t just want to sit and watch. They want to win.

AH: Exactly. Look at Chinese Internet — Tencent, Alibaba, Baidu, essentially they’re all essentially state owned companies. They might not look like it but they all march to the beat of Xi Jinping. The same is going to happen with crypto. I don’t think China wants to sit behind and let other Asian countries be more innovative and steal business but they do want to maintain some sort of control. I think there will be a period of jockeying to figure out who is the approved organization. But I fully expect that people will be able to buy and sell crypto assets in China in the near future. But the exchanges will feel more like a state owned entity than an Internet startup.

LocalBitcoins facilitates over-the-counter trading of local currency for bitcoins.

AMLG: And LocalBitcoins have exploded in the meantime right — people are still trading physically?

AH: Chinese people are still getting Bitcoin. It’s just not happening overtly. There is no more Bitcoin renminbi priced on any large exchange. The press has stopped talking about it. But Chinese people are still buying and selling Bitcoin.

AMLG: A lot of this ties to fears around capital controls. But the other side is the supply side, by which I mean mining. That’s a big question mark, noone in the U.S. has any idea what is going on in China and it’s only starting to be talked about more in the last few months. A report came out suggesting that the crackdown would extend to mining. the state run Sichuan Electric Power Corporation distributed a circular which said that grid-connected hydro power stations had to stop supplying low cost electricity to Bitcoin mining operations. That report was then debunked but there have been other reports saying the miners are considering moving their operations overseas — to Vietnam, Laos, Russia. Obviously they are afraid of talking to the press due fears over regulatory uncertainty and scrutiny into their deals with these local energy companies. When I read mining is moving to Russia that really like sets off alarm bells. What do you think about these discussions?

AH: It’s an interesting discussion because it boils down to who owns what in the mining industry. I mean it’s China so there’s no way the local governments do not have stakes in these mining farms. What’s the extent that whoever is a part owner in these mining businesses has guangxi in Beijing? I don’t know. How high up does ownership of these mining companies go? Are there Politburo members who through their networks have ownership in Bitcoin mining businesses? I would think that they have to. If I’m a miner I know that I need to pay off the government. It’s how you survive.

AMLG: It’s hard to extricate yourself from that.

AH: Right. I don’t think that China is going to stop the mining of Bitcoin. If they wanted to shut it off they would have done it already. They shut off the exchanges, which people claim is because they don’t want a bunch of grannies losing all their money on Bitcoin and starting social unrest. That’s what they care about. As for capital controls, I mean HNA, Anbang and other conglomerates do more money laundering than a Bitcoin company can do. It’s really about the fact that they don’t want a large number of people losing money quickly and causing social unrest. That’s probably why they shut down the exchanges for a while. They’ll let it cool off and then reopen it with more Chinese characteristics. Bitcoin trading with Chinese characteristics.

AMLG: Going into an area that relates to this, Bitcoin Cash and Bitmain, which is sensitive fork territory territory — it seems like any time you bring up forks in public you’re going to get shot— but it seems like you have a strict policy as stated on your website about forks, which I’ll read:

BitMEX does not agree with contentious hard forks and does not accept the manner in which Bitcoin cash was forked or the lack of preparation or notice before the fork. We consider this a dangerous action that imposes unacceptable costs on end users and businesses. However months after the fork it is clear this coin still has value and popular demand so we’ve decided to credit Bitcoin at the prevailing Bitcoin Cash price. Do not expect future coins to be credited in this way. BitMEX reserves the right to credit forks or not.

Can you explain what that means?

When Bitcoin classic (BTC) was forked in August 2017, Bitcoin Cash (BCH) was created and now has a market cap of $25 billion. BCH increases the size of blocks from 1MB to 8MB allowing more transactions to be processed. Bitcoin Gold (BTG) was created when bitcoin forked again in October. [More on bitcoin forks.]

AH: Any time there’s a hard fork it imposes a lot of responsibility and risks on a wallet provider and an exchange. In a perfect world anyone who wants to airdrop their coin using the bitcoin network — meaning if I own Bitcoin I get a certain number of coins of whatever this new thing is — so for Bitcoin Cash it was if you own a Bitcoin as of a certain block you received one Bitcoin Cash. That’s all fine and well if they include strong replay protection, meaning that by broadcasting a transaction on either chain you can’t leak these coins. From the exchange perspective you need to spend time with your wallets to make sure that in your normal business operations you will not leak your clients’ new coin. Depending on how a team or project implements its replay protection dictates how much work is incumbent upon the exchange to actually safely support the new fork. A lot of these projects are Johnny-come-lately, thinking OK I can issue my new project I’m just going to do it and I expect all the exchanges to all of a sudden spend their time making sure that they can support my new coin. We take issue with that because we don’t want to lose client assets. So we’ve made a hard stance on the fact that we want projects to give exchanges sufficient time to be able to properly and safely support their hard fork, which is why our policy is if you do want a hard fork or an airdrop or any other token that’s based on you owning Bitcoin to receive it, withdraw your Bitcoin from BitMEX before the X date, split your coins, and then come back and trade with us.

AMLG: It seems like most companies did that. Ahead of the August fork Coinbase also put out warnings. It seems like most people knew that they should probably withdraw their crypto from the ecosystem while there was a risk of a fork in place. But I guess you always have the remaining vocal folks that didn’t do that and want to be compensated. What does this mean for the spectre of future forks. We were supposed to have SegWit2X coming up and then that was called off. What does this mean if we can continue to have forks. I would think your clients want to trade on the uncertainty and different possible outcomes?

AH: Yes from a volatility perspective forks are great for exchanges. They generate trading opportunities especially for derivatives. Different derivatives trade at different prices depending on the exchange policy towards crediting the hard fork. People over subsequent hard forks now know what the BitMEX position is — we will not give you the hard fork coin. So people have been withdrawing Bitcoin before the X date if they want to receive the fork and they understand the position we are taking. Other exchanges are on a spot basis. They have a different calculus in terms of whether or not they’re going to support these new forks.

AMLG: They basically list any coin if they can make a profit?

AH: Exactly. And they’re always competing for customers so if they don’t list it they know somebody else will.

AMLG: How did you handle SegWit2X? Were there a lot of trades around that? What I had seen was 85% of miners were signaling the intention to push hashpower towards Segwit2X. But there were also other markets, chain split token markets which function like futures and showed the opposite. They showed 85% support for the one megabyte chain and only 15% support for the Segwit2X chain. That fork was meant to happen November 15th, creating temporarily or maybe permanently two blockchains. It didn’t happen. What kind of trading activity did you see around that and and did your contracts mirror these “chain split tokens”?

Arthur Hayes’ full post on SegWit2X on the BitMEX blog.

AH: BitFinex released their chain split token, and it was immediately obvious that there was not widespread support for SegWit2X. Because SegWit2X was essentially putting a gun to the head of of Bitcoin saying we’re not going to implement replay protection because SegWit2X is the real Bitcoin. They put the exchanges in a difficult position. Because they were making it almost impossible for exchanges to safely list both legacy Bitcoin and SegWit2X. However when BitFinex launched this chain split, SegWit2X started trading at something like 15% of the value of Bitcoin. You would expect if there was widespread community support for this new version of Bitcoin that it would be trading in the 40 to 50% range of Bitcoin’s value. So that immediately told us that this was a lot of hot air, a lot of posturing, that there wasn’t any real community support behind this coin.

Then I came out and called it a shitcoin on my blog. Star Xu of OKCoin followed as well calling it a shitcoin. We found out quickly when the thing actually launched that the code was garbage, they couldn’t even produce a block. They gave the wrong block height for when the fork would actually happen. It was a clusterfuck and they didn’t know what they were doing. It validated all the exchanges who expressed doubts as to the technical capabilities of this team to produce the hard fork. I think in the end we had a good outcome. The community wasn’t behind it and the SegWit2X promoters backed down.

AMLG: All very much top of mind when it comes to the civil wars of Bitcoin. Stepping back a bit, where do you see the future of BitMEX. If you had to fast forward five years what would you like it to look like?

AH: We want to be bigger than the CME in terms of notional trades. The Chicago Mercantile Exchange trades something like one and a half trillion notional worth of products every single day. They’re the biggest exchange globally. We think that the crypto asset markets present a unique opportunity for an exchange to leapfrog traditional exchanges in this sphere and we want to be that exchange.

AMLG: Leap frog in the sense that basically anyone can access BitMEX — if they have access to crypto then they can access in theory any type of financial product you create?

AH: Correct. We’re targeting retail investors who otherwise would never trade with a CME or any traditional brokerage firm because they probably don’t have a bank account they probably don’t have US dollars and they probably don’t have enough money to even buy one contract or one share of stock of something. But with the use of Bitcoin and other cryptocurrencies we can programmatically onboard customers for zero cost and offer them products with high leverage and a low capital requirement to enter. We want to capture the retail market. We’re not really focused on institutional players. We believe institutional players will come to exchanges that cater to retail traders because we offer them the possibility of actually making money in non-correlated markets.

AMLG: So it’s really a further step in democratization, in allowing people to gain access to trades and markets that they probably would have been left out of.

AH: Absolutely.

AMLG: If this all goes to plan and you make tons of money what are you going to do? Will you stay in Asia? There’s a lot of crypto rich people running around Southeast Asia trading on the beach and surfing, which sounds nice. You probably know some of those people. What is the environment out there and what would you like your life to look like?

AH: I like my life right now. I play squash. I go skiing. I go to yoga every day. I love Hong Kong. Not saying I’ll be there for the rest of my life, but I do like Asia. There’s so many different cool places to live and things to see and it would be great to experience all of those. Bitcoin is providing an opportunity for people like myself and others to travel around the world and have a better version of life than if they sat in a monolithic corporation trading or selling a traditional financial asset.

AMLG: I’m particularly curious about this because I went on vacation for the last five days, and while I was sitting on the beach I was wondering whether I could just trade crypto from the beach. When you go to these spots is there a network of these digital nomads? Do people know each other are they more lone?

AH: Yes in Thailand especially there are a few places where these people congregate. Now to trade Crypto from the beach — I think that’s a misnomer..

AMLG: The Internet’s not good enough?

AH: It’s not about that. If you are trading Bitcoin or any crypto asset it’s a 24/7 job. Trading from the beach thinking you’re going to have a chill life — that is not going to happen. You’ll quickly lose your money and you’ll be back wherever you were in your regular job. So yeah they might be sitting on the beach but these people are constantly on their cellphone checking prices. They are devoting an extreme amount of energy and time to monitoring their position. It is definitely not a job that is easy.

AMLG: Way to crush my crypto beach trading dreams. That aside, I’ve had friends and family members asking me how do I get into crypto, how do I get exposure, how do I trade. As you say it’s definitely not easy. What advice would you give to people who want to get into the game now as the price approaches $10,000?

AH: Buy an amount of crypto asset that you can afford to lose and then start sending it around, trading it, transferring it to your friends. You’ll quickly figure out whether you think it’s a complete scam or it’s the next version of our financial system. At that point you’ll devote a proper amount of energy into the field.

AMLG: So start voting with your wallet.

AH: Yes if you have money on the line you’ll quickly figure out whether this is for you or not.

AMLG: Solid advice. Thanks Arthur for taking time to chat today while you are in town. There are many topics I wish we had time to get into — decentralized exchanges, stablecoins — so much more. We’ll save them for next time. Great to catch up and I look forward to seeing what happens next with BitMEX.

AH: Thank you for having me.


*Please note that BitMEX services are restricted in the United States of America, Cuba, Crimea and Sevastopol, Iran, Syria, North Korea. See the company’s Terms of Service.

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