deen

11 Dezember 2019

Market Commentary: mechanics and structure of derivatives trading

Patrick Heusser

Patrick Heusser

Senior Trader bei Crypto Broker AG

Über den Autor

Since there has been some market chatter about the growing Bitfinex margin long positions, I thought it would be time to dig into the mechanics and structure of derivatives trading.

Margin trades and perpetual swaps

In the chart below, you can see the amount of bitcoins that are bought on a so-called margin trade.


A margin trade is a derivative. You basically buy the exposure of a certain amount of bitcoin without having the full amount of funds to do so. To be able to do it, you need to borrow money (in most cases on Bitfinex USD).

Since Bitfinex is a peer-to-peer exchange, this means that you will borrow the USD from another user who has them and is willing to lend them out at a certain rate. That rate is called the funding rate, which on Bitfinex is driven by supply/demand for USD, and on a second abbreviation driven by the BTC$ price. When the price goes up quickly a lot of people try to buy as much bitcoin as quickly as possible, and if they do not have the funds available on the exchange they borrow it.

Margin trades are very similar to perpetual swaps on BitMEX. You can buy future contracts on a leveraged basis, and if the market pushes higher in price, the funding you are charged for the leveraged capital is just like the funding rate for a margin trade. The only difference on the perpetual future is that your funding rate can also be „negative“, meaning that you will get rewarded by borrowing capital.

In both cases, you do not own physical bitcoins.

There are NOT more buyers than sellers

Now, going back to the Bitfinex margin long chart. To make one thing clear. There are NOT more buyers than sellers. That is just a stupid saying from people who do not understand how markets work. For every long position out there, there has to be an opposite trade. The real interesting point to know is what the leverage factors are on both sides (across all major exchanges, if possible).

You probably see where this is going. I believe that those Bitfinex margin longs or shorts do not give you a clear indication of which way the price will go. They might have had some potential influence at the very beginning when Bitfinex was one of the few exchanges that was able to offer margin trading (and at that time, they were also the largest exchange by volume). But today, with so many different venues to trade on, you need to look a lot closer at the holistic structure of the market.

Metrics to watch

A few metrics I consider to be vital in order to get a grasp of how the market is structured are the following:

– Open interest
– Total trading volume
– Total amount of liquidations
– CoT report (commitment of traders) from the CME
– Funding rates
– Term structure of the future market

One of the best analytic platforms to collect this data is skew.com (click on the images below).

In addition to the derivative analytics data mentioned above, I recommend you have a closer look at on-chain analysis providers, e.g. coinmetrics.io.

These providers produce very good weekly research reports on on-chain coin movements and statistics called „State of the Network“. Click here to read their latest issue.

Especially their „exchange flow metric“ is helpful in order to see if certain price actions can be linked to coin movements and exchanges. This is especially helpful when you want to better understand the supply side that comes on to the market (e.g. the PlusToken scam).

Bottom line

My bottom line conclusion is this: by looking at all of the indicators and data I have at hand, I do not see any specific set-up or outlier that could point to an immediate bigger move. If anything, I think the market is currently weaker to the downside, but the oversupply that caused the skew seems to be over.


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