Hong Kong – BitMex trades $1 trillion a year of contracts from the Cheung Kong Center
Arthur Hayes had a bad first day in finance, on the trading floor at Deutsche Bank. “I joined on the day Lehman went bust,” he says.
And it didn’t get much better after that. Hayes stuck with finance for a while, later moving to Citi, but throughout, he had the sense that he had missed out on the golden age of investment banking.
“I have experienced a secular decline in finance since the day I started, and for people in my age cohort that’s pretty much been the story,” he says.
“You’re not making the money you thought you were going to make, automation is coming to financial markets, you see fees getting sliced every year in different business lines, and you have this impression: how long is my job going to exist in its current form?”
He was right about that: he lost his job at Citi in the summer of 2013.
So Hayes decided to do something different.
By the time Citi axed him, bitcoin had started to gain attention. Hayes, a confident, gregarious man with a laugh that makes windows vibrate, is a skilled ETF and index arb trader, but also the sort of person who knows how to spot the low-hanging fruit that is so obvious everyone else is somehow missing it. In 2013 the bitcoin price in China was 20% to 40% higher than the rest of the world, because of the restrictions on the renminbi and the impeded ability of Chinese to buy things from outside China.
So Hayes, who had an account at a local Chinese exchange and an RMB bank account, would purchase bitcoin outside of China, hop across the border from Hong Kong, and sell it domestically in China for renminbi.
Since he couldn’t wire the money back to Hong Kong, he would instead take a bag of banknotes – the legal limit for taking currency across the border each day was RMB20,000 ($2,895) – and bring it back, earning his spread in cash. It was simple, bold, and entirely legal.
Thinking about what else he could do, Hayes noticed there was a very nascent futures market for the cryptocurrency, “with one exchange run by two Russian guys that no-one knew, who were located somewhere in the Caribbean.” He also noticed the futures on this exchange were trading at a heavy premium to the underlying spot price of bitcoin.
“I thought: I can sell this future, buy the cash – aka bitcoin – and earn the difference in the basis.” He tried it out, it worked, and for the next six months or so he continued to trade the arbitrage.
But what about something bigger, more institutional? “I thought to myself: I really enjoy crypto. What kind of business can I build besides trading? As you know, it’s very difficult to make money very consistently over time from trading, and I know I’m not that good.
“I thought: I’d rather have a real business rather than trying to trade my way in this industry.”
The obvious answer, given his banking background, was derivatives. “I knew that derivatives trade in much greater volumes than underlying spot markets. That’s where I wanted to go.”
The result is BitMEX (Bitcoin Mercantile Exchange), a trading platform for bitcoin offering up to 100 times leverage, bringing something like institutional norms to the crypto world. At its Cheung Kong Center offices in Hong Kong, its T-shirted executives rub shoulders with investment bankers from Goldman Sachs and Bank of America Merrill Lynch in the same building. It boasts the greatest bitcoin/dollar liquidity in the world and has traded $936.88 billion of contracts in the last year.
Setting up a bitcoin platform is not as hard as you might think. “The best thing about crypto is that it is permission-less,” he says. “When we set up, there was a set of code. There are rules, everyone who runs the software agrees to these rules, and the network functions.
“So to build anything in this ecosystem you don’t really need permission. It’s not like setting up a traditional bank or money transfer business.” Indeed, the permission-less nature of it, and its resistance to censorship, is what marks out blockchain from other systems and stores of value. Blockchain is not actually all that good for storing and transferring data. But it is good for having a common ground of accepted and borderless rules. Bitcoin, to Hayes, is simply “the killer app on top of it”.
“With bitcoin and blockchain you have a set of protocol rules that are enforced in the code and as long as you adhere to those, you can use this tech to build what you like.”
We are trying to abstract all that complexity, take out all the jargon and make it appealing for somebody who is never going to set foot on a trading floor- Arthur Hayes
Hayes incorporated his company in the Seychelles and then launched BitMEX. He set about hiring a combination of former bankers and tech experts, and then they began building products. Highlights, in addition to standard futures contracts, are a perpetual contract, which is like a futures contract with no expiry; and BitMEX Up and Down contracts, which simply allow you to go long or short on bitcoin, but without margin calls. On all products bar those last two, BitMEX offers leverage; that can go as high as 100 times on the perpetual bitcoin/US dollar contract.
So far, so familiar, to anyone who knows derivatives. “The bedrock of the underlying is definitely very traditional financial services, in terms of the type of products that we are trying to launch,” says Hayes.
But there is a difference. “We are trying to abstract all that complexity, take out all the jargon and make it appealing for somebody who is never going to set foot on a trading floor,” he says. So the perpetual swap product, for example, which was launched in May 2016, “is extremely complicated below the surface, but to the customer it’s: I can go long or short with 100 times leverage, there’s an interest rate I pay every eight hours, and I can hold my position open indefinitely as long as I can afford my margin. That’s very attractive.”
The appeal of BitMEX is that, in theory, it does well, whether bitcoin is going up or down, which is a dramatically better business case than the cryptocurrency itself (lately, anyway).
Certainly, this model has been put to the test since 2016. First, the good times.
“The market has evolved quicker than I thought it would,” Hayes says. “2017 caught everybody by surprise going from $1,000 to $20,000 at the height of the market, and the amount of trading volume and interest sky-rocketed. I definitely didn’t expect that.” Volumes went up 8,500% in 2017 over 2016, he says.
Then, the bad times. 2018 brought a crash in the price. What happened to volumes then? “Volumes are up about six times year-on-year,” he says. “It definitely proved our business model of derivatives as the place where the majority of the interested parties are trading crypto. Spot exchange volumes were obviously down pretty dramatically because the price went down, but we sustained ourselves well.”
Euromoney is interested in BitMEX because of the sense that it brings familiar, bank-honed standards of institutional behaviour to an asset class that has not typically exhibited them. But is this right? Are institutions part of the client base?
“The traditional institutional players that you’re familiar with are not involved in crypto, regardless of what press releases they put out,” Hayes says. “When I think of institutional in this context” – that is, clients on his platform – “I think of proprietary shops and partner-funded trading shops, because they don’t take or invest other people’s money.” That’s a natural constituency for BitMEX to go after: people like that, with only their own money on the line, have a lower fiduciary bar for the capital that they hold, and can therefore take more risk. “So crypto is a great asset for them: it’s extremely volatile.”
Counterparties, though, aren’t necessarily institutional in any way, shape or form. “The type of counterparties that we are dealing with are people who are believers or haters,” Hayes says. “They are coming to this marketplace and trading very emotionally, which is evident in the volatility. That’s amazing for very cool-headed statistical arbitrage-type shops.”
There are people who are using our products to hedge, but unfortunately a lot of the businesses in this field drink the kool-aid too much- Arthur Hayes
It’s not necessarily great for the investors themselves, though, but it’s a reach to ask any exchange to be responsible for the enthusiasms of retail investors: HKEx probably couldn’t say it is. Then again, HKEx is not putting 100 times leverage in the hands of retail. Euromoney is keen to see if there is some prudence in all of this: is anyone using it for hedging, for risk management?
Hayes is honest about this. “The section of the market that presents most of the liquidity is looking for leverage and returns on a very short time frame,” he says. “There are people who are using our products to hedge, but unfortunately a lot of the businesses in this field drink the kool-aid too much. They believe so much in bitcoin they leave it all on the balance sheet and don’t hedge it.”
Asked what can be done to change this, Hayes claims BitMEX does make efforts. “We are trying to encourage people to use these products to manage their cashflows and treasury management better, but unfortunately most of the most successful businesses still have a very large chunk of unhedged crypto on their balance sheet.”
How are they encouraging people to change? “We point out the failures – when XYZ company comes out with a statement saying we have to fire staff because we held all the crypto on the balance sheet.
“We say: you could have just hedged it and you would have had an awesome US dollar-linked amount of money on your balance sheet. I told you so.”
It’s easy to see the appeal for bankers joining something like BitMEX; about 25 of the 130 headcount globally have an investment banking background, with most of the rest coming from tech. Hayes’s co-founders are Ben Delo, who developed high frequency trading systems for groups including JPMorgan and IBM; and Samuel Reed, now the chief technology officer (CTO), whose background is as a programmer with a specialism in building real-time web applications.
Others with a banking background include Greg Dwyer, head of business development, who worked on the market-making desk at Deutsche Bank; Nick Andrianov, who also used to work on the Deutsche derivatives desk; and Amy Yu, in institutional sales, who spent six years in synthetic and delta one sales at JPMorgan and has also worked at UBS and Nomura.
“Crypto looks just like trading credit default swaps in the 80s,” Hayes says. “It’s opaque, inefficient, fragmented, and that’s just the market you want to be in in financial services because that’s when you make the real money, not when everything is hyper-efficient and virtuous, scalping you for a fraction of a penny.”
And that, he feels, recalls the good times of investment banking, which now seem very distant. “At all the major investment banks the compliance head is more powerful than the head of trading now. Regulations, MFID, the Volcker Rule: all these things are taking the juice out of investment banking.”
In some ways, you might argue the good times have gone from bitcoin too: regulation has stepped up in Asia, and on valuation grounds alone you couldn’t do the arbitrage trade across the Chinese border that Hayes used to anymore, or not for the same results. Volatility has come down, although it still exists in places: these days South Korea is the better example, with dislocations between local and international prices having hit as much as 25% during the bull run. “But right now is a bear market, and as volumes have declined those arbitrage opportunities have dwindled to none.” [Hayes was speaking in April; bitcoin has had a rather better time since.]
If you really think bitcoin is going to be ubiquitous and used for everyone at all points in the value chain, you need to be able to borrow and lend in crypto- Arthur Hayes
He is also not a fan of bitcoin mining. “I have not tried it. I don’t have cheap power or access to chip sets. You can’t do it as a hobbyist.”
But is he a believer in bitcoin? “Absolutely. I believe it’s a great piece of technology, something we will come to appreciate, as physical cash will get banned in most countries,” he says. When we speak he has just returned from China and noted the dominance of WeChat Pay; he did not spend a single RMB physical banknote. “That’s the future of finance.”
He’s not blind, though, to the problems of security. Euromoney puts it to him that the inherent weakness in bitcoin is not the currency itself but the standards of the exchanges that hold them.
He does not exempt BitMEX from this – “we still custody people’s bitcoin, so definitely security is the number one concern” – but BitMEX does hold much less crypto relative to other platforms. Indeed, Hayes does not think highly of those who use exchanges to do this.
“While bitcoin is supposed to be this libertarian, be-your-own-bank kind of thing, most people are pretty lazy, and are perfectly fine with buying some crypto and holding it on the exchange as if the exchange was a bank.”
This, he says, is not the idea. Individuals should buy crypto and store it themselves, not leave it on an exchange. “They’ve got these massive honeypots of bitcoin.”
BitMEX also does not allow 24-7 withdrawal, as exchanges typically do. “We set the expectation that you don’t have access to your money whenever you want it,” he says. “We will allow you to withdraw once a day at a particular time and that’s it. That allows you to have human oversight over what’s going out of the platform at any point in time. That’s not attractive for hackers.”
Perhaps the most interesting thing about BitMEX is where it might go next. A natural progression is for it to be involved in all types of derivatives, but it is fixed income that piques Hayes’ interest today.
“If you really think bitcoin is going to be ubiquitous and used for everyone at all points in the value chain, you need to be able to borrow and lend in crypto,” he says. He envisages a market of short-term paper in bitcoin, something along the lines of the CP market, “that allows people to invest their crypto in the biggest and most trustworthy companies that have tried to establish a real curve for interest in bitcoin.
“That’s definitely something we are going to get into.”
Doing so would bring crypto closer to real world applications. Once you’re into the fixed income markets, “we can really add some value to the ecosystem,” Hayes says, from buying crops to purchasing your coffee.
What are the barriers to doing that? “Number one, do people want to trade our credit risk? How would you trade it?”
BitMEX’s existence and success does suggest a more orderly conduct among crypto investors, a direction whose clearest illustration is generally thought to be the Chicago Mercantile Exchange’s decision to offer crypto futures. The two are selling very different products to very different investors, but Hayes finds it interesting that the CME is prepared to put so much into something that, today, probably makes them very little money.
“It’s definitely something that, at an executive level, they think is the future, which is great,” he says. “It means people who are outside of our little bubble do think this is here to stay and are willing to spend resources when the revenue isn’t there yet.”