Coinarch, an online trading platform based in Singapore, has
become the latest in a handful of companies offering derivatives based
on bitcoin’s value – including what the firm says is the bitcoin world’s
first ‘reverse convertible’ investment product.
The appearance of such investment products is potentially a sign
that bitcoin is maturing as a financial market, making activities like
hedging easier.
The first product in the firm’s arsenal is the Booster.
Designed for people wanting to bet on the rise or fall of bitcoin
prices (going ‘long’, or ‘short’), it offers investors leverage to
increase their potential gains.
If one person wants to bet on bitcoin prices rising, they buy the
coins, with a view to selling them later at a profit. A person going
short will borrow the coins, hoping for the price to fall so that they
can then buy them at a reduced price later.
Coinarch manages long and short orders itself by buying and selling
bitcoins. The company provides up to eight times leverage, meaning that
it will boost an investor’s $1,000 position to $8,000 for example, to
maximise their profit potential.
“To manage the risk on your position we need to buy eight bitcoins.
So we have this line of finance,” says Coinarch co-founder and CEO
Jeremy Glaros, who says that the company has raised $250,000 in capital
so far. “We also have lines of credit with shareholders.”
Customer accounts are protected using a stop-loss system, which
closes out the customer’s position to stop them losing more than their
initial investment, Glaros says. The company also charges interest and a
gap protection fee to customers.
Earning interest on bitcoins
The more complex product is the Maximiser. This investment vehicle is
designed for customers who don’t expect bitcoin prices to rise in the
short term, but still want to earn interest on the bitcoins that they
hold.
Maximiser offers them the chance to earn up to 50% interest, while also buying bitcoins along the way if the price drops.
Customers investing in the Maximiser set an maturity date for their
investment. They also agree to purchase bitcoins at a discount to the
market price, known as the ‘strike’, when the investment matures.
The Maximiser then calculates a cash settlement price, which is the
original amount invested plus a predetermined interest rate based on the
maturity date and the strike.
If the bitcoin price is below the strike when the Maximiser matures,
the customer must buy the bitcoins at the strike price. If it finishes
higher, they receive the cash settlement.
The Maximiser arrangement exposes the customer to losses should the
bitcoin price drop substantially by the Maximiser’s maturity date, but
it also gives them a healthy return on their investment should the
market stay relatively static.
Profiting from volatility
Glaros explains that Coinarch makes its money on volatility with the
Maximiser, using a probability model to determine how many bitcoins it
should buy at the market price at set intervals.
The firm’s internal modelling will offer a probability of bitcoin
finishing below the strike price, based on the current market price.
For example, when a customer invests in bitcoin at $400 with a strike
of 95%, the strike price is $380. At a current market price of $400,
there might be a 25% probability that the Maximiser matures below the
strike price (although the model is complex and the real probability may
be different).
To hedge its risk, at this point the firm buys 25% of a bitcoin (0.25 bitcoins) at that current market price.
If the bitcoin subsequently moves from $400 to $500, then the
probability of the price finishing below $380 drops (it might drop to 5%
for the sake of example). So the firm only needs 5% of a bitcoin.
To balance things, the firm sells the 20% of a bitcoin that it
doesn’t need, but this time at price per BTC of $500, profiting 20% of
the $100 price movement.
A bitcoin first
Coinarch makes money on the downside too, Glaros says, because the
customer has agreed to buy bitcoins from it at the key price,
effectively protecting it.
If the price drops to $200 from $400, the probability of the
Maximiser finishing below the $380 strike price is higher (say, for
example, 75%). So the firm buys 0.75 bitcoins at the lower price. If the
Maximiser does indeed mature below the strike, then the customer must
buy those bitcoins from Coinarch for the $380 strike price.
In investment banking circles, the Maximiser is what’s known as a reverse convertible, exposing customers to downside risk in return for potential interest.
Glaros claims it’s the first such security to make its way from the investment banking community into the bitcoin world:
“In essence, a Coinarch user who enters into a Maximiser is taking downside risk in the form of a sold put option and in return receives the elevated level of interest. This is a product offered in huge volumes globally over other asset classes, so we think it is only right that it is available in the world of bitcoin.”
The Maximiser relies heavily on volatility to make money for the
provider. Bitcoin’s volatility has shrunk during 2014, perhaps due to
greater liquidity. Below is a chart from btcvol.info, which takes its data from CoinDesks’s Bitcoin Price Index:
Glaros conceded that Coinarch’s profit potential on convertible notes shrinks as volatility flattens out, explaining:
Glaros conceded that Coinarch’s profit potential on convertible notes shrinks as volatility flattens out, explaining:“What it means is that we adjust the terms and they are less attractive for investors. We could make the case that now is the time to use this sort of thing, but ultimately what we will do is have a range of different options for customers.”
This isn’t the only interest-bearing account in the bitcoin world. Delta Financial offers one, although with a different underlying instrument. BitSavers offers 5%, and Huobi’s BitVC recently opened up internationally.
You can go long or short on bitcoin with Coinarch, or you can sit
back and collect the interest in a stable market. But with bitcoin
having been in an apparent free-fall recently, it’ll be a brave investor
who’d expect the cryptocurrency’s fortunes to stay stable at the time
of writing.
Investment image via Shutterstock.
Disclaimer: This article
should not be viewed as an endorsement of any of the companies
mentioned. Please do your own extensive research before considering
investing any funds in these products.
No comments :
Post a Comment