EDIT: This particular site does margin trading differently to how I thought margin trading normally works. So… disregard everything I just said?
Bitcoin economy and a possible violation of the efficent market hypososis.
With the growing maturity of the Bitcoin ecosystem, there has appeared a website which allows leveraged trading, meaning that people who think they know which way the price is going can borrow money to increase their profits. At the time of writing, the bid-ask spread for the rates offered is 0.27% − 0.17% per day, which is 166% − 86% per annum. Depositors are not actually trading themselves, so the only way failure modes I can see is if the exchange takes the money and runs, if there is a catastrophic failure of the trading engine, or if they get hacked.
I Gwern estimates that a Bitcoin exchange has a 1% chance of failure per month based upon past performance, but that was written some time ago, and the increased legal recognition of Bitcoin plus people learning from mistakes should decrease this probability. On the other hand the biggest exchange MtGox froze withdrawals a few days ago, but note that they claim that this is a temporary technical fault. As additional information, Bitfinex’s website states “The company is incorporated in Hong Kong as a Limited Liability Corporation.”, which would seem to decrease the likelihood of the company stealing the money.
In conclusion, even assuming a pessimistic 1% chance of failure per month I reach a conservative estimate of 65% APR expected returns (assuming that the interest is constant at the lower 0.17% figure) .
So why aren’t people flocking to the website, starting a bidding war to drive the interest rate down to a tenth of its current value? Unless there is something wrong with my previous calculations, the best explanation I can think of is that it simply has not generated enough publicity. Perhaps also everyone in the Bitcoin community is assuming the price is going to increase by 10000%, or they are looking for the next big altcoin, or they are daytrading, but either way a boring but safe option doesn’t seem so interesting. In conclusion, this seems to be an example where the efficent market hypothosis does not hold, due to insufficent propagation of information.
Disclaimers: I don’t have shares in Bitfinex, and I hope this doesn’t look like spam. This is a theoretical discussion of the EMH, not finanal advice, and if you lose your money I am not responsible. I’m not sure whether this deserves its own post outside of discussion – please let me know.
the only way failure modes I can see is if the exchange takes the money and runs, if there is a catastrophic failure of the trading engine, or if they get hacked.
The exchange can just fail in a large variety of ways and close (go bankrupt). If you’re not “insured” you are exposed to the trading risk and insurance costs what, about 30%? and, of course, it doesn’t help you with the exchange counterparty risk.
30% per annum? Even if this were true (and this sounds quite high, as I mentioned with Gwerns 1% per month estimate) then providing liquidity with them would still be +EV (86% increase vs 30% risk).
Ahh, oops. I think I missed the last line… I thought if someone exceeded their margin, they were forced to close their position so that no money was lost.
Depositors are not actually trading themselves, so the only way failure modes I can see is if the exchange takes the money and runs, if there is a catastrophic failure of the trading engine, or if they get hacked.
There is risk that is baked in from the fact that depositors are on the hook if trades can not be unwound quickly enough, and because this is Bitcoins, where volatility is crazy there is even more of this risk.
For example assume you lend money for some trader to go long, and now say that suddenly prices drop so quickly that it puts the trader beyond a margin call, in fact it puts him at liquidation, oh uh...the traders margin wallet is now depleted, who makes up the balance, the lenders. They actually do mention this on their website. But they don’t tell you what the margin call policy is. This is a really important part of the risk. If they allow a trader to only put up $50 of a $100 position and call you in when your portion hits 25% that would be normal for something like index equities but pretty insane for something like Bitcoin.
EDIT: This particular site does margin trading differently to how I thought margin trading normally works. So… disregard everything I just said?
Bitcoin economy and a possible violation of the efficent market hypososis. With the growing maturity of the Bitcoin ecosystem, there has appeared a website which allows leveraged trading, meaning that people who think they know which way the price is going can borrow money to increase their profits. At the time of writing, the bid-ask spread for the rates offered is 0.27% − 0.17% per day, which is 166% − 86% per annum. Depositors are not actually trading themselves, so the only way failure modes I can see is if the exchange takes the money and runs, if there is a catastrophic failure of the trading engine, or if they get hacked. I Gwern estimates that a Bitcoin exchange has a 1% chance of failure per month based upon past performance, but that was written some time ago, and the increased legal recognition of Bitcoin plus people learning from mistakes should decrease this probability. On the other hand the biggest exchange MtGox froze withdrawals a few days ago, but note that they claim that this is a temporary technical fault. As additional information, Bitfinex’s website states “The company is incorporated in Hong Kong as a Limited Liability Corporation.”, which would seem to decrease the likelihood of the company stealing the money. In conclusion, even assuming a pessimistic 1% chance of failure per month I reach a conservative estimate of 65% APR expected returns (assuming that the interest is constant at the lower 0.17% figure) . So why aren’t people flocking to the website, starting a bidding war to drive the interest rate down to a tenth of its current value? Unless there is something wrong with my previous calculations, the best explanation I can think of is that it simply has not generated enough publicity. Perhaps also everyone in the Bitcoin community is assuming the price is going to increase by 10000%, or they are looking for the next big altcoin, or they are daytrading, but either way a boring but safe option doesn’t seem so interesting. In conclusion, this seems to be an example where the efficent market hypothosis does not hold, due to insufficent propagation of information.
Disclaimers: I don’t have shares in Bitfinex, and I hope this doesn’t look like spam. This is a theoretical discussion of the EMH, not finanal advice, and if you lose your money I am not responsible. I’m not sure whether this deserves its own post outside of discussion – please let me know.
The exchange can just fail in a large variety of ways and close (go bankrupt). If you’re not “insured” you are exposed to the trading risk and insurance costs what, about 30%? and, of course, it doesn’t help you with the exchange counterparty risk.
30% per annum? Even if this were true (and this sounds quite high, as I mentioned with Gwerns 1% per month estimate) then providing liquidity with them would still be +EV (86% increase vs 30% risk).
Um, did you make your post without actually reading the Bitfinex site about how it works..?
Upvoted for pointing out my stupid mistake (I assumed it works in a certain way, and skipped readig the vital bit)
Ahh, oops. I think I missed the last line… I thought if someone exceeded their margin, they were forced to close their position so that no money was lost.
There is risk that is baked in from the fact that depositors are on the hook if trades can not be unwound quickly enough, and because this is Bitcoins, where volatility is crazy there is even more of this risk.
For example assume you lend money for some trader to go long, and now say that suddenly prices drop so quickly that it puts the trader beyond a margin call, in fact it puts him at liquidation, oh uh...the traders margin wallet is now depleted, who makes up the balance, the lenders. They actually do mention this on their website. But they don’t tell you what the margin call policy is. This is a really important part of the risk. If they allow a trader to only put up $50 of a $100 position and call you in when your portion hits 25% that would be normal for something like index equities but pretty insane for something like Bitcoin.