Are the Crypto Markets Broken?

Are the Crypto Markets Broken?

. 5 min read

IEOs, 100x derivatives, altcoins; the crypto markets are awash with less than desirable products, but there is hope.

It was the best of times, it was the worst of times, then there was crypto trading. Bitcoin just topped $8,000 and yet we are still lacking robust trading products for crypto. Part of this is regulatory, in that many derivatives are simply not legal to trade yet. Part of this is that low cost alternatives to existing offerings simply haven’t been created yet. Price discovery is hampered due to this lack of options, but there is hope on the horizon.

IEO's

In 2017/8, ICO’s sold billions worth of tokens simply by creating a smart contract and issuing tokens from it in exchange for ETH. The problems with this method are infinite. Without taking into consideration the regulatory violations, there was no proper due diligence process a company would needed to follow before conducting the sale. This lead to untold number of scams, project failures, and other malfeasance on the part of the company. Even if a project turned out to be legitimate, there were no guarantees for token holders that one of the quality exchanges would ever list them. My own portfolio has a few tokens which are too illiquid now to even sell. They will forever remain as trophies showing the terrible decisions I made.

Initial Exchange Offerings (IEOs) solve the two problems listed above and are the marketing geniuses newest way of trying to shill projects to retail clients and drive demand. Due diligence is handled by the exchange, offsetting some of the risk in investing into crypto projects. The big problem solved is liquidity. Listing on a top exchange ensures a project will be liquid and tradeable from day one, allowing token holders to exit their positions without incurring slippage.

Listing the IEO comes with a new set of risks for the exchange. First, the exchange must prove its reputation by selling out the IEO quickly. Second, the exchange must show a multiple return on every IEO to retain its reputation. Both of these are interconnected, if an IEO does not sell out, then there is almost zero chance that it would debut at a higher multiple post launch. If an exchange cannot guarantee a multiple to their clients, then the IEO won’t fill and it will be considered a failure. After one or two failures, the exchange’s reputation is damaged beyond repair.

The difference between Binance and Bittrex IEOs is a good example of this. All of Binance IEOs have sold out in seconds and their returns have been positive. All of Bittrex’s IEOs on the other hand have failed to raise the hard cap or have suffered losses post IEO. Ocean Protocol lost more than 80% of its value post-IEO as soon as investors could dump.

Exchanges do everything in their power to prevent losses from an IEO. Typically, the amount of tokens sold in an IEO is below 2% of total float and the price per token is less than what private sale investors paid. It’s this second characteristic which has angered many private sale investors, myself included. Most token sales occur in stages, with the earliest investors receiving the most advantageous price for the risk of opportunity cost and potential project failure. The time elapsed between initial private investment and public listing frequently extends beyond a year. When terms are changed unilaterally, private sale investors have every right to be angry. Reserve, for example, sold tokens to private sale investors at $, however, when they conducted their IEO, tokens were sold at $. Upon listing the price was $, a x return for private sale investors and x return for IEO investors.

IEOs show no signs of stopping either. Binance continues to conduct immediately sold out token sales and scandal ridden Bitfinex just announced the launch of Tokenex, their IEO platform which is planning to conduct more than 80 offerings in the next year. None of these offerings are legal in the eyes of the SEC and so no Americans can take part, however, they can trade the tokens afterwards. How long they can continue without regulator action I cannot say, but it seems tenuous at best.

Derivative markets

The fastest way to lose your Bitcoin is to go 100x on Bitmex or one of the dozen other derivatives exchanges. These proto-casinos are designed to quickly separate traders from their funds. Don’t tell crypto twitter this though, as most high-follower accounts typical are shilling their referral link to unsuspecting rubes.

The issue with Bitmex is in how the contract is designed. At non-leveraged levels, the fees that Bitmex charges are actually very reasonable. Makers collect .025% and takes pay .075%, leaving Bitmex with .05% on every trade. High leverage though scales linearly with the fees. At 100x, the fees paid by a trader are 7.5% for taker and 2.5% received for maker, while Bitmex pockets 5%. These fees are astronomical. At 100x and Bitcoin at 8000, after taking price must move at least $6 in order to break even. Additionally, liquidation levels on Bitmex are far closer to purchase price than on other exchanges. With 100x, you would expect liquidation to occur at -95%+ loss, but on Bitmex, they occur at -75% loss, a massive gap when trading with high leverage. The difference in liquidation levels removes a buffer which would normally give traders extra cushion. Bitmex’s insurance fund has grown exponentially due to rekt plebs making poor decisions with high leverage.

Even beyond the point about leverage, the swap contract is a highly expensive product. Every 8 hours, funding is paid from shorts to longs, or reversed, depending on the gap between the spot price and index price. Larger deviations result in higher funding prices. During times of high price volatility, funding premiums can exceed 400% a year, while normal funding rates are 50%. Most long term traders I know tend to stay away from swaps, instead using futures.

CME futures are a great product. But it’s hard to access them and the margin requirements are extremely steep in comparison to their notional value. One contract requires over 10k USD to trade 5 BTC notional, approximately 25% margin-to-notional and equivalent to 4x leverage. CME futures require a brokerage account and are cash settled, meaning you aren’t actually buying and selling Bitcoin, just against the index. One of the best futures exchanges I can recommend is Coinflex (you can read our exchange guide and listen to the podcast here). You can fund your account with Bitcoin and also take profits back in the digital currency.

Altcoins

Not much has to be said about highly illiquid tokens that can’t be shorted. Every time Bitcoin makes a run, altcoins are destroyed. For some reason though, rekt plebs still seem to keep on taking the risk. Pro-tip: stick to BTC and ETH.

What’s coming

The two biggest projects crypto traders are waiting for are Bakkt and ErisX.

The former is a physically delivered futures product, similar to what Coinflex is offering, but regulated and available to US markets. Bakkt will offer a “daily settlement bitcoin future, which will enable customers to transact in a same-day market and a monthly bitcoin futures contract will enable trading in the front month and across the forward pricing curve.” They also will provide regulated custodianship, a breakthrough for the market. Much hype has been created around Bakkt, as the company has partnered with Starbucks and other retailers to enable in-store crypto payments.

ErisX on the other hand is a new high-frequency exchange funded by a recent $20 million investment from TD Ameritrade. Crypto trading will now be offered to users of the brokerage and I expect other traditional brokerages to start partnering with them as well. ErisX has received funding previously from Arc Light Securities, Castle Island Ventures, Dragonfly Capital Partners, Flow Traders, Tradestation, NYDIG, Cboe Global Markets, CMT Digital, ConsenSys, CTC, DRW Venture Capital, ED&F Man Capital Markets, Nasdaq Ventures, Pantera Capital, Susquehanna International and Virtu Financial. These heavyweights are building the next evolution of crypto trading markets.



Subscribe to our podcast on iTunes