Trade Bitcoins, Ethereum, Litecoin Online

I frequently get asked about how to trade crypto currencies. Aspiring traders see the daily swings in the bitcoin price and wonder whether they should take up trying to pick the highs and lows by trading. This post will describe some trading methods and provide you with a list of venues where you can trade.

The first thing to understand about crypto currencies such at bitcoin, ether, and litecoins, is their value is represented by their market price which is simply set by the powers of supply and demand. There is no central authority that determines their market price, so if you want to profit from the daily price swings, you’ll need to have a trading strategy that takes advantage of this volatility.

You’ll also need to choose your trading venue(s). Where you trade will be based on your trading strategy, but also on your legal/tax jurisdiction. Since you’ll need to comply with the laws of your local government, you should choose exchanges that are compliant for you. The place where you trade will be different if you’re American, Canadian, European, Japanese, etc. And sub-state governments such as provinces and states will also have their own laws. It’s common today for each US and European state to regulate bitcoin differently so do careful research to ensure you are trading in a tax compliant way.

The place(s) where you trade will also depend on your strategy. If you are arbitraging the bitcoin price between different exchanges you’ll need to hold accounts at more than one place, and also have wallets that serve as conduits/transfer nodes for cash, if you’re making your trades manually you’ll be more concerned about the trading dashboard and other human readable analytics, but if you’re using a bot to conduct your trades you’ll need the best API access with easy to use functionality.

Here is a step-by-step tutorial of how to trade on QuadrigaCX, a Canadian based bitcoin exchange. Once you open your account, you can fund it with Canadian dollars using Interac if you verify your account. You can also fund your QuadrigaCX account with bitcoin, ethereum, and litecoin without verification.

Once logged into QuadrigaCX, choose the “trade” tab from the header menu near the top of the page. As the image below shows, you’ll arrive at a page that shows the current market for CAD/BTC with a simple interface you can use to buy and sell. You’ll notice the best bids are listed on the left side in green, and the best offers are listed on the right side in red. These prices are bids and offers from other users on QuadrigaCX just like yourself who are buying and selling. You might be familiar with a market like this since it operates just like a stock market such as the TSX and NASDAQ.

 

 

You’ll notice on the image above, the current market has a best bid of $9,995.01 and a best offer of $10,000.06. This means another user is willing to buy at $9,995.01 and another user is willing to sell at $10,000.06. If you’d like to make a trade right away (a market order) you can sell to the user bidding $9,995.01 and buy from the user offering $10,000.06.  Depending on your trading strategy, you might only be willing to buy at $9,500, so in this case, you can place a order at that price and join the other bids in the order book. Your order will be placed with the quantity you determine at $9,500 until the market drifts down to that level and another user chooses to sell you their bitcoins at that price. Conversely, if you’d like to sell your bitcoins, but only at $10,500, you can place this order as well.

On QuadrigaCX, limit orders placed manually on the dashboard do not have expiration dates, so all orders are essentially good till cancelled (GTC).

As you review the order book from the image above, you will also notice an “amount” beside each price listed in the order book. This is the quantity being bid or offered by all users at that price. This quantity will help you determine whether your order can be filled entirely at the posted price or whether you should choose to pay up or offer down from the best posted price.

 

 

When trading, always keep the fees in mind QuadrigaCX charges an explicit fee of 0.50% per transaction. So if you buy 1 bitcoin at $10,000 CAD, your actual cost will be $10,050. You should also pay attention to the “spread”, which is the difference between the best bids and offers. Using the example above, with a current bid of $9,995.01 and an offer of $10,000.06 the spread is $5.05 or 0.06%. The spread represents an implicit cost of trading too.

Here’s an example of an easy to implement manual trading strategy with a bullish bias. Say you have $1,000 CAD to trade with, you’ve noticed the price of bitcoin is quite volatile, so you plan to make a market on QuadrigaCX to take advantage of this volatility. You will risk 10% of your account with each trade so your unit size will be 0.01 bitcoins since the current price is $10,000.

You place an order to buy 0.01 btc @ $9,993, which is slightly below the current market price using the example image above. You place the order and wait for the market to come to you, when your order is filled, place an order that is 3% above your purchase price (9993 * 1.03 = $10,292), enter your order to sell 0.01 btc @ 10,292 and leave the order in the market.

In the meantime, if you’re still feeling bullish, place another order below the current market, and if this order is also filled, place an order 3% above your fill price. Keep doing this until you reach the maximum value of your account. As you do this, the price of bitcoin will bounce around going up and down, and your orders will fill at prices where you make a spread between your buys and sells. You profit when the price of bitcoin trades within the range of volatility your limit orders imply, and you lose when the price of bitcoins drops straight down.

This is a simple market making strategy with a bullish bias that takes advantage of the volatile price of bitcoin. You can obviously tweak your own strategy to suit your own goals. You could use technical analysis to choose your entry and exit points, etc. Its completely up to you!

Follow this link for a long list of exchanges from around the world.

Crypto Credit Events

Crypto currencies, such as bitcoin and ethereum, are growing rapidly and the opportunities for profit are enormous. But these markets are also highly risky and investors using crypto currencies shoulder this risk. The situation should make risk management a main area of focus for crypto investors.

Risk in the crypto currency markets shows up in a variety of ways including many different forms of financial, tax and other operational risks. Much of the counterparty credit risk found in crypto currency markets comes from undeveloped crypto market infrastructure. We just don’t have the same plumbing in crypto currency financial markets as we do in fiat based financial markets. Fiat economies have developed the rule of law, deposit insurance, and credit ratings, but none of these these exist in crypto currency markets. Crypto currencies also don’t rely on any central authority, so dispute resolution is much more problematic, if not impossible. If your crypto currency wallet gets hacked, for example, you have little (or no) recourse to recover your loss.

Interestingly, the lack of financial market infrastructure also presents profit opportunities. Many financial services businesses operating in developed fiat economies could be replicated by clever entrepreneurs to crypto economies. The opportunities are huge.

Consider the cryptocurrency investor who makes a deposit on Bitfinex or Poloniex, and then lends their crypto currency to traders on the exchange in return for interest. How can this investor estimate the chances the exchange will remain solvent, and how can the investor estimate the chances of their account suffering a loss in the event the exchange gets hacked?  At present, there are very few ways to quantify the risks of such events. The crypto currency investor is left to rely on message boards, online posts, and a poll of their friend’s opinions. These methods are unscientific, and won’t give the investor reliable metrics they can use to make investment decisions. The average crypto currency exchange depositor simply relies on their own “gut feeling” along with some basic rules of thumb about portfolio management to make risk management decisions (don’t put all your eggs in one basket).

As far as I know, there doesn’t currently exist any method of obtaining deposit insurance for a crypto exchange or hosted wallet balance. In developed fiat economies, deposit insurance makes it cheap for consumers to assess the credit risk of counterparties, but the cryptocurrency world doesn’t currently have this same infrastructure. I believe that creating a rating agency for crypto currency credits is required for crypto currency finance to reach a more sustainable path.

One of my main goals as an investor is to better assess the creditworthiness of my cryptocurrency counterparties, and then use this information to make better investment decisions. As an investor, the degree of credit risk matters to me. Mostly all crypto currency investments have counterparty risk, but few ways exist to assess this risk. In fiat currency economies, we can rely on rating agencies, deposit insurance, and many different forms of information to make credit decisions. But this this same market infrastructure does not currently exist for most crypto currency finance.

To enlighten the market, the first step should be to define a credit event. When is a counterparty in default?  Below, I outline five categories of credit events: Bankruptcy, Acceleration, Default, Failure to Pay, and Restructuring.

Bankruptcy

Bankruptcy occurs when a relevant regulator declares the organization to be bankrupt.

Acceleration

Acceleration covers the situation, other than a Failure to Pay, where the relevant obligation becomes due and payable as a result of a default by a reference entity before the time when such obligation would otherwise have been due and payable.

Default

Default covers the situation, other than a Failure to Pay, where the relevant obligation becomes capable of being declared due and payable as a result of a default by the reference entity before the time when such obligation would otherwise have been capable of being so declared.

Failure to Pay

Failure to Pay is defined to be a failure of the reference entity to make, when and where due, any payments under one or more obligations. Grace periods for payment are taken into account.

Restructuring

Restructuring covers events as a result of which the terms, as agreed to by the reference entity and the holders of the relevant obligation, have become less favourable to the holders than they would otherwise have been.

By the above definitions, I believe it would be possible to achieve consensus on whether a credit event has occurred. The process of determining consensus could be done by a system of member voting and/or a pari-mutuel pool. The result of the credit event determination process could be used to settle derivative markets such as default insurance pools. These default insurance pools could in turn be used by market participants and credit rating agencies to help determine the creditworthiness of underlying entities. The pools themselves could also be used by both speculators and hedgers to manage their investment risk.

Price of a Binary Option

Consider an underlying price of 918. You are presented with the choice of buying or selling a European binary call option with 1 day till expiration and a strike price of 918 (i.e. at the money). The 30 day historical volatility of the underlying, as measured by standard deviation, is 5%, and the risk free rate is 1.50%.

Since this is a binary option, the bet is about whether the underlying price is going up or down tomorrow. So how should this option be priced?  If the price of the underlying is more than 918 in a day, the binary pays off 1, if the price is lower than 918 in a day, the binary pays off 0. Is this a 50/50 bet?  An amateur would say the option should be worth 0.50 since there is an equal chance of each event happening. But the price of this binary call is actually worth slightly more than 0.50. How so?

To value the option scenario described above, we need to consider the (1) time value of money and (2) the volatility of the underlying. If we use a black-scholes model, with the variables listed above, we come up with a call price of 0.506.

Try out various calculations on this example, check out the CME binary calculator link, here.

Using the same variables, but changing the time to expiration, comes up with the following values.

Days till Expiration Binary Call Price
1 0.506
30 0.531
90 0.552
180 0.572
365 0.599

Thoughts on the Basic Income Guarantee

Although I’m morally opposed to a basic income guarantee because it provides a negative incentive for citizens to live an economically productive life, I do think a basic income guarantee will become politically palatable in many jurisdictions as unskilled labour becomes less valuable. I believe the economic gap between the most skilled and motivated people and the rest will become wider with the further development of technology. At least in the most developed economies, we are getting closer to a time when its politically cheaper for society to tax the most economically productive and wealthy, and redistribute the tax to the rest, in the form of a straight payment. A society where anyone can simply choose to be a full time consumer can exist because we are creating the necessities of life in an increasingly productive way. Many of the extra fun things in life such as art, media, sports, are nearly free. Unskilled labour is becoming more of a political liability than a productive asset. Although the moral implications of the basic income guarantee are ruinous, it looks more likely to become reality.

EconTalk has a good discussion of some of the main issues.

What is Provably Fair Gaming?

In the “olden days” before the internet, casinos had to demonstrate their trustworthiness to players in order for players to have confidence they were being dealt a fair game. In places such as Nevada, the state also took on this responsibility by providing a regulatory system that ensured casino games are being dealt fairly, and extended the system to various electronic games and slot machines. Bucket shops online and in back rooms still pray on the uninformed and careless, but with greater access to online information, it has become easier for gamblers to find fair games by using an innovative cryptological process called Provably Fair.

What is Provably Fair and how can it be used to prove a game is fair? Provably Fair is a cryptological process that allows players to verify the randomness out an outcome. This is done by using an open source algorithm for random seed generation, hashing, and for the random number generator. Players can use such algorithms to test a game’s response to in-game decisions and evaluate the outcome by only using the published algorithms, seeds, hashes, and the events which transpired during the game. A provably fair game provides players with the tools to have confidence that a game is fair without requiring third-party verification.

The concept of Provably Fair was first implemented by BitZino back in 2012. Bitzino is a bitcoin casino that wanted to prove that its games were fair without having to register with a state based authority. Provably Fair methods do not require bitcoins or other digital currency, but the concept of provably fair matched well with a bitcoin based casino since the digital currency is extra-territorial.

Basically, bitZino deployed a cryptographic hash function (SHA256 algorithm) to create a digital fingerprint of an already shuffled deck. Since the SHA256 hashing algorithm is one-way and there’s no way a player can use that hash to figure out what the shuffle of the deck actually is, the casino can let players look at the hash before the game starts. Two “seeds” of data are needed, one provided by the casino called the server seed and another provided by the player called the client seed. The client seed is typically provided by the player’s browser.

Then, the vitural deck is reshuffled using the Fisher-Yates shuffle algorithm with the random numbers generated from the Mersenne twister algorithm that was seeded with a hash of the combined server seed and client seed. According to bitZino, “The second round of shuffling only serves to ensure that neither the server nor client could possibly know the final deck before the game starts.” Finally, the initial shuffle and the server seed are provided to the player for verification.

The provably fair method used by Bitzino set off a flurry of developments within the bitcoin gambling community. With provably fair technology, it is now a lot cheaper for online casinos to operate fair games since 3rd party verification of game fairness is not required and provably fair gaming also makes it safer for players since we now have the tools to test whether a casino is provably fair, thereby reducing the risk of being cheated. In the wake of provably fair, a group of “provably fair verification” services emerged to make it easier for players with less technical knowledge to test provably fair games.

Comparing Crypto Margin Lending Sites

As the digital currency financial system develops, a new type of investment is emerging: margin lending. Currency exchanges have created platforms for their users to take out margin loans in order to make leveraged currency trades and the margin funding itself is also provided by users. This goes against the traditional system of brokers providing margin. This development makes sense because it takes the exchanges out of the credit side of the transaction, and focuses their role on maintaining a market and processing transactions. The exchange still needs to work on providing users with a margin exchange that promotes liquidity by offering participants a fair marketplace. The relative success of each exchange will depend on the rules accompanying their own system.

The table below shows the simple APR for various margin lending platforms for various currencies. The way I calculated the rates in the table was to take the midpoint of the bid/ask in the current market at the time of writing then multiply this midpoint price by 365 to arrive at an annual rate.  I understand this calculation doesn’t take into consideration such factors as compounding, but the table below still gives us an idea of relative rates of return.

  USD BTC ETH
Bitfinex 17.53% 1.57% 7.14%
Poloniex N/A 6.28% 1.99%
OKCoin 31.02% 27.37% N/A
BitVC N/A 0.37% N/A

The first thing I noticed from this table is the widely divergent rates between each platform and between currencies. Each of the markets listed in the table provides bitcoin margin lending markets and the rates that can be obtained from each site are widely different. The rate on Bitfinex for BTC is so low as to compare with the rates offered by regulated banks in the fiat economies of North America, whereas the rate for BTC at OKCoin is at a massive 27.37%.

The best rate for both USD & BTC can be found at OKCoin, and OKCoin also offers CNY margin lending markets as well. So let’s look at the mechanics, liquidity, and rules of OKCoin in particular to see why this might be the case. OKCoin is based in mainland China and does not allow US based customers. This might partially explain the high rates for USD as there might be a lack of supply for these types of margin loans, but not the high rates for BTC. The mechanics at OKCoin for the margin lending market are pretty straight forward, with an open market of bids and offers and an auto-renew feature. The exchange states the margin rules call for forced liquidation in the event a trader’s margin falls below 10%. Without much experience on this platform or data at my fingertips, its impossible for me to say whether the risk of default is large. Judging by the high rates at OKCoin, default sounds like a real possibility. The exchange offers a service called “insurance” which costs 10% of the value of the interest earned. Whether this is a good or bad deal, or the details of coverage don’t seem to be disclosed. The fact that insurance costs a nice round number like 10% makes me think the exchange is up-selling coke & fries with margin orders.

Bitfinex is the largest crypto currency exchange and provides the platform with the most usability and an ecosystem of data from BFXData that publishes useful information from the exchange. Although Poloniex trades the most currency pairs and also has the most currencies listed for margin lending, Bitfinex is the most liquid and the market at Bitfinex is currently offering higher rates on Ether.

I wonder how these markets will develop? In terms of regulation, these exchanges will be in a constant negotiation/battle with regulators, particularly in the US & China. It might be beneficial to be located in a 3rd party country in order to fly under the radar of the shifting regulatory landscape. Another factor to keep in mind as these platforms develop is liquidity. A lack of liquidity might be a bad thing in terms of getting orders filled and keeping money invested, but a lack of liquidity could also offer opportunities for higher rates (being compensated for the lack of liquidity) and also arbitrage and hedging between platforms. I think as more margin lending groups start using APIs to move faster between platoforms, the rates of returns between platforms should converge. But maybe not, if the margin rules between exchanges are different, those different rules will mean different risks, which means different rates.

How Volatile is Bitcoin?

A frequent criticism of bitcoins from the lay person revolves around the perceived bitcoin price volatility compared to fiat currencies such as the US dollar.  But although this type of commentary is common, its often not backed up with any type of data.  The assumption that the price of something is volatile is not itself proof of the fact.

I thought it might be helpful to publicize a website that tracks the volatility of bitcoin prices as measured by standard deviation. Standard deviation is a backward looking measurement of historical volatility. At present, there is no reliable source of implied volatility data about bitcoin due to the lack of an open derivatives market, so historical volatility is the best we can do right now. Here is a link to The Bitcoin Volatility Index, which is a website that tracks the standard deviation of various bitcoin prices.

Its important to keep in mind when discussion the bitcoin price (or any price for that matter) that the price of something is simply a expressed ratio between the value of two things. So to say there is one price for something assumes a standard base currency. We take this for granted since in North America at least, most of us use either the Canadian dollar or US dollar to buy and sell things during our daily lives at the retail level. But theoretically we could also value goods and services by any other price ratio too.

How does the volatility of the bitcoin/US dollar price compare to other currency pairs or other assets?  The price of bitcoin is indeed more volatile than CAD/USD, CNY/USD or any other major fiat currency pair. This may be because most central banks around the world have similar monetary systems and policies, therefore, they all tend to move in the same direction (whether you think these directions are “right” or “wrong” is beside the point). But what about the volatility of Gold/USD or other assets? It turns out the bitcoin price has also been much more volatile.

At this point in bitcoin’s history, its price has a similar level of volatility as stocks.  The historical 30 day standard deviation of the price of bitcoins/USD is currently 1.39 according the btcvol.  I used the standev excel function and data on the SPY from Google Finance to calculate the standard deviation of the SPY and got 2.09. So right now, over the past month, stocks/USD is more volatile than btc/usd. But they are close.

Zimbabwe is starving itself

The government of Zimbabwe is declaring a state of emergency because of food shortages within the country.  This is a very sad situation, made even worse because the ways to ensure food is available are well known and easy for policy makers to implement.  The problem for Zimbabweans is their government is unwilling to allow a free market in food. Instead, the government blames a poor crop for causing starvation, but if free markets were allowed, bad weather wouldn’t impact the availability of food.  If free markets were allowed, farmers would simply purchase insurance against bad weather and consumers would be free to purchase imported food. Part of the reason behind the current food shortage is the government has increased the taxes on imported food in an effort to raise money for itself, but at a drastic cause to its citizens.