This document discusses Bitcoin derivatives, including what they are, common types like futures and options, their uses for hedging and shorting Bitcoin, and considerations for trading them. It provides an overview of the current landscape and growth potential for Bitcoin derivatives, using the example of BitMEX, a new exchange offering these products.

1. Bitcoin Derivatives

2. Topics Covered
• What is a derivatives contract?
• Bitcoin derivatives use cases
• Trading considerations and risks
• Simple arbitrage strategies
• Present and future of Bitcoin derivatives market
• BitMEX – Bitcoin Mercantile Exchange

3. What Is A Derivative?
• A contract between two parties based on the
outcome of an event
• The underlying can be any asset or outcome
• Can be either exchange traded or OTC
• We will talk about CFDs, Binary Options,
Futures, Forwards, and Options

4. Exchange Traded vs. OTC
Exchange Traded Derivatives
• Standardized contract terms
• Centralized clearing and margin
• Fungible
OTC (Over The Counter)
• Bespoke contract terms
• Margin determined counterparty by counterparty
• Not fungible

5. Types Of Bitcoin Derivatives
Futures & Forwards Contracts
• Contract to buy or sell an asset at a specified price on a
future date
CFDs (Contract For Difference)
• A cash settled futures or forward contract
Options Contract
• Right but not the obligation to buy or sell an asset at a
specified price on a future date.

6. Bitcoin Derivatives Use Cases
• Shorting Bitcoin
• Reducing volatility
• Allow traders to hedge future cash flows
• Create more advanced Bitcoin financial products

7. Shorting Bitcoin
• Derivatives allow traders to synthetically sell
Bitcoin they don’t own
• Alternative is to borrow Bitcoin, then sell on spot
market
• Bitcoin borrow market under developed
• Shorting promotes a healthy market structure

8. Bitcoin Volatility

9. Bitcoin Volatility
0%
50%
100%
150%
200%
250%
300%
1
13
25
37
49
61
73
85
97
109
121
133
145
157
169
181
193
205
217
229
241
253
265
277
289
301
313
325
30D Realized Volatility Jul ‘13 – Jun ‘14

10. Bitcoin Volatility
• Derivatives allow traders to avoid the spot
market
• Quicker execution allows traders to dampen
price swings
• Ability to short easily dampens upward volatility
• Options market allows the trading of volatility as
an asset

11. Hedging
Payment Processors and Merchants

12. Hedging Future Cash Flows
Merchant signs order to deliver shoes for fixed
payment of Bitcoin in one month
• Has fixed costs in USD
• Will receive payment in BTC in one month
• Exposed to currency risk for one month
• Cannot sell BTC spot as they have not received payment
• Can sell BTC, buy USD forward via a derivative

13. Hedging
Fund Managers

14. Hedging ETF Inflows
ETF listed in USD that gives exposure to Bitcoin
• Investors pay USD for the ETF
• Fund manager must gain long exposure to BTC
• Fund manager can either buy spot or derivatives
• Buying spot uses 100% cash
• Buying derivatives uses < 100% cash
• Excess cash can be deposited in money market funds
• ETF performance is enhanced

15. Bitcoin Financial Products
• Principle Protected Notes
• Volatility Indices and Swaps
• Single Stock Bitcoin Futures Contracts

16. Trading Bitcoin Derivatives

17. Margin Calls

18. Margin Calls
Initial Margin
• Equity required to open a position
Maintenance Margin
• Minimum equity require to hold a position
• If your equity falls below this level a margin call is issued
Leverage
• E.g. If maintenance margin is 20%, leverage equals 5x

19. Counterparty Risk

20. Counterparty Risk
OTC Traded Derivatives
• Risk that counterparty cannot pay up
• Risk that counterparty loses or steals margin funds
Exchange Traded Derivatives
• Risk that exchange has faulty margin policy
• Risk that exchange cannot cover bankrupt traders
• Risk that exchange loses or steals margin funds

21. Pricing Bitcoin Derivatives
CFDs, Futures, and Forwards
• Covered interest rate parity
• Where can you borrow and lend BTC vs. fiat
• Contango vs. backwardation
Binary and Vanilla Options
• Black Scholes model
• Implied vs. realized volatility

22. Simple Arbitrage Strategies

23. Spot Exchange Arbitrage
Exchange A $500, Exchange B $550
1. Construct a portfolio of half fiat, half BTC
2. Sell BTC futures to hedge
3. Deposit fiat on A, BTC on B
4. Buy BTC on A, sell BTC on B
5. Withdraw fiat from B and transfer BTC from A to B, and
repeat

24. Spot vs. Forward Arbitrage
1m BTC forward = $1,000, BTC spot = $800
1. Borrow USD
2. Sell USD, buy BTC on spot market @ $800
3. Buy USD, sell BTC forward @ $1,000
4. After one month the forward expires at the spot price
5. Buy USD, sell BTC on the spot market
6. Pay back your USD loan, the residual is profit
7. If you borrow USD < 25%, then put on the trade

25. Current Derivatives Landscape
• Very few exchanges
• Thinly traded
• Limited number of tradable products
• Expensive funding charges

26. Future Growth
Fiat Currency Market
• Forwards and options ADV of $1.017tn (BIS)
• Heavy presence of corporates and banks
Bitcoin market
• Forwards and options est. ADV $0.5 – $1MM
• Dominated by individual retail traders

27. BitMEX – Bitcoin Mercantile Exchange
• Centrally cleared exchange
• Offering futures and options on BTC vs. fiat
currency pairs
• Margin, profit, and loss all in Bitcoin
• July 1 paper trading game with 10 BTC prize
• Sign up at BitMEX.com