The financialization of cryptocurrencies

What does it mean to “own a Bitcoin?” It means there’s a recorded transaction on the Bitcoin blockchain where someone sent one bitcoin to your public key address which you (and you alone) know the address’s private key. albeit that terse description explains things, it doesn’t help with the logistic details of how you set about doing this. it’s complicated. But it’s also complicated to physically buy and hold a bar of gold or a barrel of oil. Google it. you’ll make it happen, but it’s work.

Bitcoin, like many commodities,

has been “financialized.” There are now financial contracts you’ll buy and trade which may be even as good as (or better than) literally having an entry on the Bitcoin blockchain. What does financialization and therefore the growing role played by centralized cryptocurrency exchanges mean for everyday investors?

Investing in Bitcoin

by directly owning a bitcoin on the blockchain creates an extended position that appreciates because the value of Bitcoin (in US dollars, say) increases. If you owned a coin, you’ll sell it. there’s no mechanism inherent to Bitcoin’s blockchain that permits you to make a brief position — a bit like you can’t sell a physical bar of gold you are doing not have. Financialization facilitates adoption of long positions and makes the adoption of short positions feasible.

For many, the simplest thanks to invest in Bitcoin is to use a financial organization like Coinbase. This transaction is straightforward , in part, because Coinbase doesn’t literally sell you a bitcoin. Instead, Coinbase issues you a liability denominated in bitcoins and backs its liabilities with (bulk) transactions of bitcoins on the blockchain. The tradeoff for the convenience of the transaction (and security) is that the risk you bear from the institution. this is often analogous to “money” you retain within the bank which actually is dollar-denominated bank-issued liabilities whose safety depends on the health of the bank and regulation; your money isn’t literally dollars during a vault somewhere.

Cryptocurrency exchanges

like Kraken, Binance, and BitMEX also offer financial contracts that mimic ownership of bitcoins. More importantly, these exchanges allow you to trade “short” in order that the worth of your position rises when the worth of Bitcoin falls. They also allow “leverage” where position values may increase (or decrease) at quite one-to-one with the Bitcoin price.

In new research with collaborators at Carnegie Mellon University, we study cryptocurrency exchanges using data we compiled from BitMEX. Founded in 2014, BitMEX was particularly successful due to its innovation of a “perpetual futures contract” whose price tracks the present Bitcoin price but facilitates both leverage and short trading. BitMEX was less successful in their plan to avoid US regulator jurisdiction. Here are a couple of observations about financialization in Bitcoin we draw from our deep dive into this exchange. Most of our data is publicly available on our interactive companion website.

The “how” of financialization matters

Designing a financial instrument involves many choices. Exchange traded financial contracts for typical commodities like oil are standardized. a number of these contracts, like many oil contracts, are settled physically requiring physical delivery of a particular sort of oil to a particular location. Other contracts are settled financially where rather than oil you receive the cash-equivalent of a barrel of oil measured from some index price.

BitMEX tried many various contracts before introducing the perpetual derivative instrument that now generates a majority of the quantity on BitMEX (and many other exchanges). On the surface, the perpetual futures is analogous to a forward contract. But a couple of details leap out as different and important.


BitMEX settles in bitcoins (you invest in and obtain back bitcoins) while long positions held in perpetual futures gain when the (familiar) US dollars per Bitcoin Index price rises. this suggests that the settlement currency (Bitcoin) appreciates as long positions appreciate; for many forward contracts, the settlement currency (US Dollars) depreciates as long positions appreciate. Using Bitcoin to settle trades makes “long” and “short” positions behave in less familiar ways.


the contracts leave leverage. With 0.01 Bitcoin you’ll enter a contract of “size” one Bitcoin. Your profits (and losses) move 100 times quite the change in Bitcoin prices. Frequently, positions find yourself with a zero balance (called a “liquidation”). These positions are “non-recourse” then zero is that the boundary on the account. That zero may be a likely outcome means the “futures” contract looks more almost like an “option.” Interestingly, to guard the exchange from losses, BitMEX liquidates your position before it hits zero. that tiny buffer is one source of profit for BitMEX and important when thinking of the market price of those contracts.

This feature is more common in swap contracts. BitMEX and other exchanges promote these contracts as an easy thanks to invest in Bitcoin and yet these contracts blend features from forward, option, and swap contracts in complex ways.

Trading on BitMEX

is round-the-clock and not the quality 9:30 AM and 4 PM. of Wall Street. In cryptocurrency derivatives markets, the trading volume shows little time-of-day pattern. Moreover, round-the-clock trading reflects partially people within the same time-zone trading every minute of the day.

The participants of cryptocurrency exchanges include small and enormous retail investor. Traditional institutional investors, and funds specializing only in cryptocurrency. this is often an unusual mix for a derivative market. Our data show occasional large transfers among these traders and specifically from small accounts to large accounts.

Financialization changes the way people can invest in Bitcoin. The impact of financialization on the worth of Bitcoin is a smaller amount obvious. Making it easier to shop for bitcoins increases demand, but exchanges that facilitate “short’’ contracts let pessimists express their views. More subtly, financialization may change the way people use Bitcoin. for instance. Tesla’s ability and desire to simply accept Bitcoin for payment could also be enhanced by the power. To hedge price fluctuations on an exchange. Conversely, the high leverage in some cryptocurrency exchange markets. May create instability cycles where volatility in cryptocurrency prices dive which drives further volatility.

So, what does financialization and therefore the growing role played by centralized cryptocurrency exchanges mean for everyday investors? It means it’s easier to take a position in Bitcoin without owning Bitcoin directly. Exactly what this suggests for your portfolio may be a much harder question.

From time to time, we invite industry thought leaders, academic experts and partners. To share their opinions and insights on current trends in blockchain to the Blockchain Pulse blog. While the opinions in these blog posts are their own, and don’t necessarily reflect the views of IBM. This blog strives to welcome all points of view to the conversation.

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