Interest Drops for Bitcoin Futures

For the first time, open interest in bitcoin futures declined since being listed on the CBOE as of December 10, 2017. Based upon data released today, open interest dropped from 6,932 to 5,704 or 17% for the week ended February 13th. Prior to that, the open interest in bitcoin futures contracts had been steadily climbing.  

The reversal came during the same week when the spot price of bitcoin increased from about $7,700 to $8,600, per coinmarketcap. Low price volatility during the week may have contributed to the declines in both short and long positions of leveraged funds, which includes hedge funds; long positions declined 20% and short positions declined 24%.

More Hedge Fund Bitcoin Shorts

Short positions on bitcoin futures held by hedge funds increased 20% this week. That is based upon CFTC data on the CBOE bitcoin futures for the week ending February 6th.  In addition, hedge funds commanded more than one half of the approximately 6,900 short positions also for the week ending February 6, 2018.

In addition, the amount of open interest increased 20% from the prior week. Based upon the current spot price of bitcoin, the CBOE’s bitcoin futures market is now worth about $58 million. While large, the market size may not be large enough to support a futures-based, bitcoin exchange traded funded.

This is based upon this week’s remarks made by SEC Chairman,  Jay Clayton, before the Senate Banking Committee.

… there are a number of issues that need to be examined and resolved before we permit ETFs and other retail investor-oriented funds to invest in cryptocurrencies in a manner consistent with their obligations under the federal securities laws. These include issues around liquidity, valuation and custody of the funds’ holdings, as well as creation, redemption and arbitrage in the ETF space.

The CFTC data next week may show activity from traders rolling over expiring bitcoin futures contracts into new ones.  On February 14th the current XTB/G8 contracts will end; so there may be traders replacing their old XTB/G8 contracts with the newer XTB/H8 contracts which expire next month on March 14th.

Crypto Pioneer, Polychain, Creates Two New Funds

Polychain Capital founder and super smart, Olaf Carlson-Wee, creates two new funds. Last week it was reported that Carlson-Wee will begin selling securities to potential limited partners in a new vehicle called, Polychain Ventures LLC, which was formed in October 2017.

What has not been reported until now, is that at the same time, Carlson-Wee created two other funds: Polychain 2030 LLC and Polychain Meta LLC.

Carlson-Wee founded Polychain Capital in August 2016 for investing primarily in crypto assets – currencies and tokens. Polychain Capital has about $250 million of crypto-assets under management.  Now with Polychain Ventures, Carlson-Wee will begin investing in blockchain technology which has been done by other crypto-funds.

What’s important here is the timing of the filings and fundraising.  Why it Matters? Could these and other developments signal the top of the current crypto-boom? All three fund filings occurred last October when Bitcoin was reaching new highs.

Last week, it was reported Carlson-Wee’s Polychain Capital was considering a Canadian initial public offering for about $325 million. Selling to the public would in effect allow Carlson-Wee to monetize his crypto-asset portfolio without actually having to sell any crypto-assets; and why not sell stock when crypto-prices are (were) at all-time highs.

With the all new money, Carlson-Wee seems to have found that blockchain technology is now more attractive rather than crypto-currencies and tokens.


Art of the Trade, No Bullish.


A short trade on Bitcoin last month made a killing for some hedge funds based on data published last week by the Commodities Futures Trading Commision (CFTC).

Near the end of December, when Bitcoin spot was about $16,000, hedge funds sold CBOE XTB futures, betting the price of Bitcoin would fall. And when Bitcoin spot reached about $11,000, the hedge funds closed out their positions, netting about $6 million.

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Traders use futures for profiting  from either price increases or decreases. Futures are financial contracts between two parties for the delivery of and payment for assets at a future date. One party is long, hoping price will increase and the other party is short, hoping things will go the other way.  

In the stock market, you can close out your position by selling the security, but with futures you either hold the contract to expiration, which most do not do, or you establish an offsetting position.

If you think prices will go down, then you would sell futures. When the your position is profitable, then you will exit the position by buying futures.  

As of December 26nd, hedge funds sold 1,138 contracts worth about $18 million when Bitcoin spot was about $16,000. Then last week, when Bitcoin spot was $11,000, hedge funds sold about 1,142 contracts, worth $12 million; netting the $6 million in profits.

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Taken together, the buying and selling, offset or cancel each other; in effect the hedge funds exited their position.  At least that is what appears to have happen given that the number of contracts sold (1,138) is almost the same as the number of contracts purchased (1,142).

What appears to be two sides of the same trade was mistaken by some (WSJ here or here) to be a bullish signal, which was not the case. Some only saw one side of the trade.


Alpha, Beta, and Crypto Funds


HFR just debuted new indices aimed at blockchain and cryptocurrencies. HFR stands for Hedge Fund Research and the new indices measure the performance of twenty hedge funds investing in blockchain and trading cryptocurrencies.  So far this year, the HFR Cryptocurrency Index alone has risen 1,635%. But one must wonder if that performance is skill or just luck?

In the hedge fund world there is either alpha or beta returns. Beta returns are earned from just going with the market and don’t require great expertise. Whereas alpha returns required something extra, something more. If the S & P 500 Index is up 20% in one year, then you would want your hedge fund manager to earn more than that, but most do not. For in most professions there are the Jordans, Kanyes, and then everyone else.

Alpha returns in crypto may eventually come from some type of edge: a social network, a technology insight, or a trading acumen.

For example, former Fortress employee and macro  trader, Mike Novogratz, who made his $250 million crypto fortune from a “small” bet on ether back in 2016, will open his first fund next year, called Galaxy Investment Partners. Olaf Carson-Wee co-founded Polychain Capital with money from Andreesen-Horowitz  and USV. Carson-Wee’s edge comes from his social and intellectual capital developed as one of the first employees of Coinbase.

Recently Techcrunch founder, Michael Arrington, announced in late November his own fund focused on blockchain and crypto. As a former venture capitalist, Michael Arrington will be leverage his own social network and tech expertise. Out the gate, Arrington did score a first by establishing the first fund denominated in XRP, the cryptocurrency of Ripple Labs.  The XRP Capital Fund will only use XRP as investment from and redemptions to limited partners.

Since crypto funds are relative new, investors won’t really know for a while whether they’re paying for alpha returns from fund managers. It’s worth noting that most of the run up in the HFR Cryptocurrency Index came in 2017 when lots of new money flowed into the crypto-space.

So right now there might only be beta returns in the new crypto funds.


The Big Short, Again?


Just in time to burst a bubble, there comes this Sunday bitcoin futures come the Chicago Board of Trade (CBOE) and more later from the CME. Now there is way to bet against the tremendous rise in bitcoin. It’s almost similar to the housing bubble a decade ago when credit default swaps were applied to mortgage backed securities to short the real estate market. But in this Big Short, who will be on either side of the trade?

Unlike the stock exchange, in the futures market there is only one winner.  For every short position, there needs to be a long one since futures are a zero sum game. In effect, the short trader is betting prices will go down while the long trader hopes prices will go up. In order for a futures market to survive, there needs to be enough shorts and longs; or said another way, there needs to be enough hedgers and speculators.

Who would do the bitcoin short trade? Companies, firms, and individuals who are holding lots of bitcoin and who may not like the price of bitcoin going down. For them, the short trade is a side bet: if bitcoin goes down in value, the losses are offset by gains from the futures contract. Given the volatility of bitcoin, anyone doing business in bitcoin can not necessarily afford loses after receiving payment in bitcoin.

Online retailer, Overstock, who receives bitcoin and other cryptocurrencies as payment could be a short seller, a hedger. Overstock may use futures to lock in the value of their bitcoin holdings. Circle Financial may be another hedger given the volume of cryptocurrency transactions used its cross-border payment business. Circle no longer deals directly in bitcoin, after pivoting to doing payments. Its product is free and Circle makes money by trading bitcoin and other cryptocurrencies.

While it’s hard to predict the success of bitcoin futures, it’s helpful to remember that the CME lists futures contracts on real estate, based upon the Case/Shiller Home Prices Index. Despite being listed since 2006, the real estate futures never took off due to a lack of hedgers, speculators, and market liquidity.

Other than hedge funds and some business, who is willing to bet against the rapid rise of bitcoin?


Wall St. Comes to Bitcoin, For Good.



As announced by the CFTC, new bitcoin derivatives were self-certified by the CME, the Chicago Board of Trade (CBOE), and the Cantor Exchange this week. That news means that bitcoin futures and binary options will soon be listed and provide another way to trade bitcoin. While the CFTC did not actually approve the new contracts, its involvement may benefit traders of bitcoin futures.

Trading bitcoin futures has advantages over trading real bitcoin. Besides leverage and shorting, bitcoin futures receive a preferential or lower tax rate on gains. Trading actual bitcoin could mean any gains are taxed as ordinary income. For example, if one trades bitcoin and is in the 35% tax bracket, then a gain of $10,000 would mean taxes of $3,500 due to the government. But with bitcoin futures, the amount due is only $2,600.

For tax purposes, it appears that bitcoin futures will qualify as Section 1256 contracts. That designation means that sixty percent of the gains are taxed as long-term capital gains and the remainder as short-term capital gains. It also results in the favorable tax rate.  Section 1256 contracts are futures contracts that are subjected to marking for market for margin purposes  and trade on a qualified board or exchange (QBE).  

A QBE is a domestic exchange that operates under the oversight of the CFTC such as the CME or Chicago Board of Exchange.  The CFTC regulates futures on commodities  and two years ago it stake a claim on regulating bitcoin futures. In a case against Coinflip Inc, the CFTC said among other things that bitcoin was a commodity; that meant futures on bitcoin would be regulated by the CFTC.

In 2014, the IRS classified bitcoin for tax purposes as property rather than as a commodity. As property, gains from trading bitcoin can be subjected to ordinary income tax rates, which can be large for people in high tax brackets. But those same people could have lower tax bills when trading bitcoin futures rather than real bitcoin.

Disclaimer: This post is intended only for educational purposes. It should not be relied upon for investment or tax advice. Interested parties should instead consult with their investment and tax advisers.


Bitcoin Futures for the People



Dueling bitcoin futures come out soon from Chicago. One from the CME and the other from the Chicago Board of Exchange (CBOE). Much has been made of futures contracts on bitcoin, but the contract specifications themselves are most important for market participants. CME’s bitcoin futures favor institutional investors while those from the CBOE are beneficial to individuals.

Futures are financial contracts for the delivery of and payment for commodities on a date in the future. In the past, the commodities were physical assets such as corn and then financial assets like bonds and stocks, starting in the 1970s. Now, bitcoin is the commodity. Futures can be use to shift risk, speculate on price, and act as a substitute for the commodity itself.

Futures contracts can be purchased on margin, similar to the down payment when buying a house. Each futures exchange (CME, CBOE) sets the margin percentage and amount of margin is based upon the contract’s value. So if margin is 30% and the contract value is $10,000, then only $3,000 is needed to purchase the futures contract.

Contract value is based upon a multiple of the underlying commodity, in this case, bitcoin. CME’s  bitcoin futures multiple is five while only one for CBOE’s bitcoin futures. So if one bitcoin is worth $10,000, then contract values are $50,000 and $10,000 respectively. This means, that less margin is required to trade the CBOE bitcoin futures and than for those from the CME.

It also means bitcoin futures from the CBOE will favor the individual, rather than the institutional investor.


Coinbase Custody: Cheap?


Coinbase found another way to make money off cryptocurrencies with its custodial services for institutional investors. Announced this week, Coinbase Custody will charge sovereign wealth funds, traditional hedge funds, family offices, and others 10 basis points to store digital assets, such as bitcoin, litecoin, ethereum, and ERC 20 tokens. For some, there may be cheaper way to own digital assets.

At this moment in time, cryptocurrencies acts less like currencies and more like commodities. Often bitcoin is called digital gold; a storer of value rather than means of payment. This is due in part to the limited transaction processing of the bitcoin protocol. But owning digital asset presents custody issues for institutional investors.

The situation is no different than fifteen years ago when institutional investors wanted to own real commodities, such as industrial metals and agricultural products. As with digital assets, owning real assets is challenging due to storage, transportation, and insurance costs. Back then Wall Street solve the challenge by providing institutions with synthetic exposure with derivatives: commodity swaps, exchange traded futures, and structured notes.

So it is ironic, that this week the CME announced the terms of its BTC futures contracts. The CME is home to many of the future contracts that make up the commodity indices that institutions invested in many years ago; this includes the Goldman Sachs Commodity Index. CME’s bitcoin futures could be listed in the second week of December and will required more margin than “traditional” contracts.

While sovereign wealth funds or hedge funds may opt for real digital assets, others may want only synthetic exposure. CME’s BTC futures contracts offer another way for institutions, including mutual funds, to provide bitcoin exposure by rolling over the futures contracts, much the same way as with traditional commodity futures. BTC futures can also simplify ownership for retail investors with the creation of synthetic bitcoin exchange traded funds; one of which was recently proposed by Proshares.


Apple Really Likes Trump’s Tax Plan



Facebook, Alphabet, and especially Apple will really like Trump’s Tax Plan.  Under the various proposals, repatriated overseas cash receives a special tax break for US corporations.

Per the most recent SEC filings, 60% of Alphabet’s cash was overseas, Facebook held about 37% of its cash, overseas, and 94% of Apple’s cash was held overseas.