Analysis | Crypto innovation needs traditional finance


Although there are innovations in the app economy to match supply and demand for physical services (think: Uber’s surge pricing), there is no peer for real-time balancing of volatility in financial markets.

The world of “intraday” funding — that is, money borrowed during the day as opposed to overnight — remains highly dependent on excess profits from central banks, even as Federal Reserve officials move to accelerate the pace of this withdrawal in September and October. Once this free liquidity is restored, liquidity can easily reappear, causing both overnight and long-term markets to collapse. If they do, market participants will have to come up with their own solutions — or go along with the Fed and risk isolation.

Believe it or not, the crypto world — never one to settle for a lender of last resort — can now look to it for inspiration on how to navigate this tight environment.

As an example, let’s take the perpetual swap (or perpetual future as it’s also known). In the year Since its creation in 2016, crypto trading has become extremely popular in the highly popular world, as it allows analysts to take artificial positions that eliminate the risk, cost and friction associated with moving or managing real cryptocurrency. If a password is lost, it can be hacked, mismanaged, or inaccessible.

As with conventional derivatives, the perpetual futures never differ from the value of the crypto space to which it is referring. Usually, if you buy one-month, two-month or three-month futures, the price will reflect a premium or discount relative to the reference price – known as the basis. The perpetual swap design, by creating an active price for daily funding, prevents that.

The combination of being able to trade crypto artificially and without initial costs has helped make BitMEX, which originally introduced the contract, a key destination for crypto trading and a billion-dollar enterprise. In response to popular requests from users, the Eternal Exchange has since been replicated on many other exchanges.

And yet, despite being one of the most important financial innovations to come out of the crypto space, perpetual swaps remain largely unknown in the world of traditional finance. This is mainly because the contract is intraday crypto vs. The role that the dollar plays in promoting liquid prices is not well understood, even by crypto traders who frequently use the contract.

This is particularly true of premium index mechanics, which are contingently backed by the contract. The concept of the index originated from the realization that BitMEX co-founder Ben Dello, who was most responsible for the innovation of the perpetual exchange, realized that if he wanted to remove basis risk from his calculations, he needed to make traders pay. Separately. (In February, as part of a plea deal, Dello and his BitMEX co-founders pleaded guilty to violating the US Bank Secrecy Act.)

In Dello’s thinking, if traders who want to go long the market are forced to pay active funds to those who take the opposite view just to keep positions open, this encourages clients to take the other side of the trade. The process balances the system and combines the perpetual contract with the bitcoin spot value. The premium index is a way of determining the funding amount, which is based on the current funding amount of the perpetual contract or the level that was in place. Any difference will be used to adjust the amount for the next eight hour period.

It is an open source method of this type that can be applied to the conventional FX swap markets (and others) to help traders strengthen funding conditions. Like Uber’s pricing system, if inconsistencies are seen and exposed, they are paid by the market to move the market to the other side. In theory, this short-term liquidity shortage would reduce the likelihood of escalating into more widespread systemic liquidity problems or those that would need to be tapped through regular central bank channels.

So far, JPMorgan Chase & Co.’s attempt to develop an internal “coin” to ease the bank’s internal funding balance comes close to any serious effort to address similar problems in the financial system. The bank was motivated to do so by being a “second-to-last-resort” lender in the market, having previously boasted an often excessive amount of cash on its balance sheet. This means that banks often try to borrow from JP Morgan before even thinking about going to the Fed’s overdraft facilities.

But seeing only two major lenders in a day is not very good. Adapting innovations such as the Perpetual Futures System to dollar markets increases the options for cashing in when there is a severe dollar shortage, which becomes an even bigger opportunity than when there is no surplus.

It is important to remember that all overnight funding issues come from within if they cannot be effectively aligned in time. The only reason the market never developed its own tools to better day-trade money is because it had no qualms about using the Fed’s overdraft facilities until the global financial crisis. Since then, quantitative easing has hidden the issue of imbalance. But the Fed’s tightening approach could change that.

Fortunately, thanks to the eternal volatility, we have the tools to effectively intraday trade currencies. They should be creative as soon as possible.

More from Bloomberg Commentary:

• Jackson Hole Should Be Mea Culpa for Central Bankers: Marcus Ashworth

• The era of the economic crisis is just beginning: Eduardo Porter

• China’s economic caution is a problem for all of us: Daniel Moss

This column does not necessarily reflect the views of the editorial board or Bloomberg LP and its owners.

Isabella Kaminska is the founder and editor of Blind Spot. She spent 13 years at the Financial Times, most recently as FT Alphaville editor.

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