Category Archives: derivatives

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Is Derivatives Trading Harming the Bitcoin Market?

BitMEX, short for Bitcoin Mercantile Exchange, consistently has the highest trading volume for any cryptocurrency exchange by far, such as USD 2.5 billion in volume versus Binance’s USD 1.3 billion on July 5, 2018. However, BitMEX is usually excluded from cryptocurrency exchange ranks because it primarily trades derivative contracts that represent a certain amount of bitcoin instead of spot trading actual bitcoins.

BitMEX offers up to 100 times leverage, meaning customers can invest the USD equivalent of 1 bitcoin into their margin account and buy 100 BTC worth of derivatives contracts. This means that BitMEX can ‘print’ 100 times more bitcoins than they really have, which is obviously dangerous.

Customers have the choice of going long or going short. When going long, the customer holds onto the Bitcoin contracts, and if the market goes up then they gain money. If a customer is going short they sell the contracts immediately and the USD goes into their margin account, and if the market goes down they buy the contracts back for less money to repay the loan and keep the USD profits.

Therefore BitMEX provides a mechanism for people to place large bets on the Bitcoin market declining. Theoretically, whales with large amounts of bitcoin and other influential people can collaborate to drive the market down and make huge profits by using maximum leverage on their short sells.

The 2008 global financial crisis provides an excellent example of how derivatives trading can be extremely harmful. Derivatives based on real-estate mortgages proliferated in the years leading up to 2008 and soon comprised a large fraction of the assets that banks, corporations, and investors held. Housing prices declined and homeowners defaulted, causing derivatives backed by real-estate to become worthless. Many people had unknowingly put a large amount of their life savings and retirement funds into these derivatives via their financial advisors, and lost their money.

The derivatives market collapsed, and banks stopped trading with each other because banks usually offered derivatives as collateral for loans. The resulting financial crisis was the worst since the Great Depression and was only stopped by world governments printing trillions of dollars in fiat to bail out the corporations and banks, at the expense of the people.

The lesson of this story is that derivatives can appear to have value and be considered an asset but actually have nothing backing them. BitMEX has up to 100 times more contracts than the actual amount of USD deposited on the exchange, which could lead to a disaster if Bitcoin’s price goes up and BitMEX is forced to pay out the contracts. BitMEX doesn’t have the USD to honor the contracts and would have to shut down.

This makes it suspicious that Bitcoin’s price has been going down so consistently while BitMEX volume has rapidly increased. This is the market situation BitMEX needs to survive, and the question whether such players are attempting to manipulate the cryptocurrency’s price is something that crops up in everyone’s mind now and then.

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UK Financial Conduct Authority Warns Firms About Crypto Derivatives

The UK Financial Conduct Authority (FCA) has issued a warning to firms that deal with cryptocurrency derivatives, as they likely require authorization from the agency to do business.

Posted Friday on the official FCA website, the statement advised that cryptocurrency derivatives have the qualities necessary to be considered tradeable assets. As the statement reads, this means that firms involved with regulated activities using cryptocurrency derivatives are subject to FCA guidelines, as well as any relevant provisions indirectly applicable to European Union regulations.

Despite the FCA declining to acknowledge cryptocurrencies as either currencies or commodities in regards to regulation, the statement notes that it is ”likely” that firms offering cryptocurrency derivatives require authorization to do so.

This would potentially require companies holding initial coin offerings (ICOs) to comply with the FCA guidelines, although the statement noted that this would depend on the nature of the token offered.

Other areas outlined that would fall within the FCA’s regulatory parameters include cryptocurrency futures, cryptocurrency contracts for differences (CFDs) and cryptocurrency options.

The final warning of the statement precautioned firms that neglecting to authorize activities under the FCA’s regulation is a criminal offense. The statement finished, ”Authorized firms offering these products without the appropriate permission may be subject to enforcement action.”.

The FCA on the industry

In 2016, the FCA said that there were no plans in place to regulate the blockchain industry for the time being, as it needed what it described as space to develop.

However, the agency has been outspoken on its unfavorable view towards cryptocurrencies and ICOs. Chief executive of the FCA Andrew Bailey said in December 2017 that Bitcoin investors must be prepared to ” lose all your money”. He compared cryptocurrency investments as similar to gambling.

December 2017 also saw the FCA announce a further study into ICOs, scheduled to determine if there was a need for further regulatory action depending on the applicability of UK laws to the investment model of ICOs.

 

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