Crypto Derivatives: On Misleading Measurements

Crypto Derivatives: On Misleading Measurements
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.Crypto Derivatives 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 to which the derivative contract gives exposure. 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.

Bitfury Partners to Launch Bitcoin Mining Centers in Paraguay

Bitfury Group and South Korean R&D firm Commons Foundation are jointly launching a network of bitcoin mining operations in Paraguay. Announcing the partnership on Thursday, Bitfury said a series of mining centers will be set up in the South American country using its BlockBox AC bitcoin mining devices. Further,  the mines will be powered by two major hydroelectric power plants, Itaipu and Yacyreta. The collaboration is a part of Commons Foundation’s Golden Goose project, backed by the government of Paraguay, which aims to establish the area as world’s largest crypto mining center given the country’s ample supply of cheap and clean electricity. Paraguay currently only utilizes roughly half of the electricity produced by the two plants, according to Bitfury. Sandra Otazú Vera, a senior staff attorney in Paraguay and advisor to Commons Foundation, said that Paraguay is exploring “creative ways to use emerging technologies, like blockchain and cryptocurrencies, to benefit their economy and their citizens.” Commons Foundation is also planning to launch a cryptocurrency exchange in Paraguay later this year. The platform will integrate Bitfury’s compliance analytics platform Crystal, according to the announcement. Bitfury, which specializes in manufacturing crypto mining infrastructure and also mines itself, is reportedly considering an initial public offering (IPO) in Amsterdam, London or Hong Kong, possibly to be held early this year. In November 2018, the firm raised $80 million in funding led by venture capital firm Korelya Capital, with Mike Novogratz’s Galaxy Digital, Macquarie Capital and Dentsu Inc. also participating. Source: www.coindesk.com

Ripple Partners With Chinese University for Blockchain Research Program

Ripple has partnered with a top Chinese university for a blockchain research program. The Institute for Fintech Research (THUIFR) at Tsinghua University in Beijing announced last week that the scholarship program would focus on global regulatory policies and blockchain development. Selected students will also get to participate in corporate visits and events. Ivy Gao, director of international cooperation and development at the university, said that the initiative is aimed to provide students a “comprehensive view” of global blockchain regulatory policies, adding that he believes it would help students with their “future research or career in the field of blockchain technology.” Eric van Miltenburg, Ripple’s SVP of global operations, said:
“The program’s goal – to provide students with opportunities in blockchain research – closely aligns with that of Ripple’s University Blockchain Research Initiative; we’re thrilled to support THUIFR in this endeavor and look forward to its launch.”
Back in June, Ripple announced it was putting over $50 million into academic research into blockchain through the university initiative. It partnered with 17 universities from across the globe at the time, including institutions in the U.S., Australia, Brazil, Canada, Europe, India and South Korea. Blockchain research projects from educational institutions around the world have received funding support from government agencies as well. Earlier this month, the U.S. Department of Energy announced federal funding of up to $4.8 million for universities working on R&D projects, including those related to blockchain. Source: www.coindesk.com

Thai Stock Exchange Plans to Launch a Token Trading Platform

The Stock Exchange of Thailand (SET) is looking to capitalize on investor interest in cryptos by offering a new digital assets exchange. According to a report from Bangkok Post on Thursday, the SET is planning to apply for a license from the country’s Ministry of Finance to operate the platform. The move comes as the exchange looks to capture the growing investor demand for cryptos, Pattera Dilokrungthirapop, vice-chairwoman of the SET board of governors, said in the report. The stock exchange will work to have a sound technical system in place for the offering, as well as a digital wallet for token storage, with the aim being to launch this year. Pattera, who is also chairwoman of the Association of Securities Companies, added that securities company members of the SET already plan to apply to become brokers and dealers to trade on the new exchange. In May of last year, the SET launched a crowdfunding marketplace built on blockchain technology. The service, dubbed LiVE, uses blockchain to enable peer-to-peer trading in an effort to help startups access new capital from investors, including those drawn from the venture capital and institutional investor worlds. Last week, the finance ministry granted digital asset business licenses to four firms: Bitcoin Exchange, Bitkub Online, Satang Corporation (Satang Pro), and Coins TH Co. Two other firms, Cash2coin and Southeast Asia Digital Exchange (SEADEX), were denied the license, while a third application from Coin Asset is still under consideration. While the ministry grants the licenses, the country’s Securities and Exchange Commission actually regulates crypto businesses in the country under the “Emergency Decree on Digital Asset Businesses B.E. 2561 (2018).” Thailand first announced its crypto licensing rules in July of last year, with 20 crypto firms applying for the license within a month. The rules require projects that intend to offer crypto services to gain approval from the SEC before starting operations. Source: www.coindesk.com

This Malware Has a Worrying Trick to Mine Monero on Cloud Servers

A recently observed form of malware uses a concerning new trick to avoid detection and mine cryptocurrency on cloud servers. Two researchers, Xingyu Jin and Claud Xiao, from cybersecurity firm Palo Alto Networks, published a report on Thursday, saying that a nasty bit of software from bad actors dubbed the Rocke group is targeting public cloud infrastructure. Once downloaded, it takes administrative control to first uninstall cloud security products and then inject code that mines the monero cryptocurrency. The researchers found that the Rocke malware injected code to uninstall five different cloud security products from infected Linux servers – including offerings from top Chinese cloud providers, Alibaba and Tencent. Adding insult to injury, the malware follows the uninstall steps set out in the products’ user manuals. To do its malicious work, the Rocke group exploits vulnerabilities in Apache Struts 2, Oracle WebLogic, and Adobe ColdFusion applications, and then downloads a shell script named “a7.” This knocks our rival crypto miners and conceals signs of its presence, as well as disabling the security programs. The researchers add:
“To the best of our knowledge, this is the first malware family that developed the unique capability to target and remove cloud security products.”
The Rocke group malware was first discovered by IT giant Cisco’s Talos Intelligence Group back in August. At the time Talos researcher David Liebenberg said that Rocke will “continue to leverage Git repositories to download and execute illicit mining onto victim machines.” Back in November, research from Israel-based cybersecurity firm Check Point Software Technologies showed that a monero mining malware, dubbed KingMiner, is evolving through time to avoid detection. Monero remains by far the most popular cryptocurrency among hackers. Last week, a study by college researchers showed that hackers have mined at least 4.32 percent of the total monero in circulation. A study from McAfee, published in December, showed that instances of crypto-mining malware grew by over 4,000 percent last year. Source: www.coindesk.com