The BitMEX arrests: what happened, is it good or bad, Arthur Hayes’ bravado, and the aftermath (Column)
What happened?
On October 1st, Federal prosecutors from the Commodity Futures Trading Commission and Department of Justice filed criminal charges in Manhattan against BitMEX chief executive Arthur Hayes, along with 3 other company executives. The criminal charges accuse them of allowing money laundering and other illegal transactions to occur on the exchange.
According to the New York Times’ Nathaniel Popper:
Prosecutors said BitMEX had taken few steps to limit customers even after being informed that the exchange was being used by hackers to launder stolen money, and by people in countries under sanctions, like Iran.
BitMEX did not require the same identity checks that most exchanges do, until this year when they started getting some pressure from the Feds.
Only recently, they also added a top-line banner on their website. It says they reserve the right to liquidate the trades of anyone who doesn’t comply with their Terms of Service, especially based on their Restricted Jurisdiction rules.
So it seems they have been operating with the mindset, “build aggressively now, apologize later.”
What is BitMEX known for? (Highly leveraged) Futures trading
BitMEX is known for being a crypto derivatives trading platform. They offer the opportunity to trade several different kinds of futures contracts, on several different cryptocurrencies. Besides Bitcoin, these include Bitcoin Cash, Ethereum, Litecoin, Ripple, Cardano, Tezos, and others.
With a normal security like a stock or just simply buying Bitcoin, you only can bet “long” — that is, that price will go up.
Futures allows traders the ability to bet “short” — that the price will go down.
The other thing with trading futures is that one can heavily leverage their trade. BitMEX offers up to 100X leverage on Bitcoin futures, and 20X — 50X on other currencies.
100X is massive leverage. That means the trader only has to put $1 down to trade a $100 contract. The contract is basically tied to the price of the currency, so if the trader is betting the price will go up, and it goes up 1%, then the trader has doubled her investment (or a 100% increase). But the opposite is true too — a small change in the price in the opposite direction can wipe out 100% of the trader’s down payment (or margin).
Forget trading cute 2X and 3X leveraged ETFs on your favorite brokerage site, this is the land of the Wild West!
BitMEX is hosting huge volumes, and making real money themselves
According to Popper and the NYT article cited above, BitMEX is regularly a Top 5 daily volume crypto exchange, and consistently the 2nd largest crypto derivatives exchange, often hosting upwards of $1.5B in trade volume per day.
After about 7 years in business now, BitMEX is clearing big money in trading fees on this roughly $1.5B per day. Extrapolate $1.5B per day over a year, and that’s over half a trillion dollars in volume.
They are making real cheddar, that part we do know.
Nouriel Roubini was extremely critical of BitMEX going back to July 2019
If you’re familiar with Nouriel Roubini, you’ll know he’s an interesting and relatively prominent economist. He became known as “Dr. Doom” as he predicted the 2007-2009 economic crisis. He also wrote a book on policy options to deal with downturns, Crisis Economics, in 2010.
More recently, he has become known for being very anti-crypto. In July 2019, he sparred with BitMEX CEO Arthur Hayes in an hour long debate that has been dubbed, “The Tangle in Tapei.”
Basically, Roubini’s stance is that crypto is purely speculative, with no fundamentals to assess real value. As such, he believes the crypto space broadly, and especially an exchange that allows clients to recklessly trade in 100X and similar leveraged crypto securities, is actually extremely damaging.
Roubini is ruthlessly critical of BitMEX, and isn’t quiet about calling Hayes activities ethically challenged. He basically says what Hayes and BitMex are doing should be illegal or at least regulated, so in this sense Roubini aligns with the US Federal Prosecutors’ position.
He points out that BitMEX is technically headquartered in the Seychelles (a small island country north of Madagascar), and as such is completely unregulated.
Is Roubini right or wrong about BitMEX? Is it fundamentally bad?
Putting the bit about not acting on money launderers aside (I think most would agree on that part), is BitMEX, and are other exchanges like it, fundamentally bad?
Roubini cites one example of a college student he apparently knew who realized big losses after using his student loan money to speculate on crypto (with leverage).
That is probably a dumb thing to do by the student, and probably should be scored as a human problem, not an exchange problem. The bottom line with leveraged futures of all sorts is that, don’t bet what you can’t afford to lose.
Extending that line of thought, what are “normal” or “traditional” futures based on? All sorts of securities and commodities, actually — pork bellies, orange juice, soybeans, palm oil, ethanol, natural gas, zinc, steel, lean hogs, you name it.
When someone takes a long or short position on any of these commodities, they are speculating. There’s no rule that says prices will go one way or the other. The price by definition is such that there is money coming in on both sides. Seen this way, crypto doesn’t seem different than these commodities, so the instinct is that there’s no problem running a functional, liquid, professional brokerage for crypto futures.
But Roubini’s point is that these futures markets are regulated by the CFTC. That means stricter identity information requirements (less money launderers), more investor accreditation up front (less college students), and no such thing as 100X leverage (less severe pain of loss).
Roubini rejects the BTC store of value argument too
On the other hand, Roubini doesn’t seem to want to acknowledge the “Bitcoin as store of value” argument, which is much more widely accepted at this point. That is to say, seeing Bitcoin as just like gold, but better from a technology standpoint in every way (supply is perfectly fixed, greater ease of movement, more easily divisible, more efficient to trade and store, etc.).
Another way of describing the store of value argument is that Bitcoin is like a hedge. It is a hedge against other asset classes, such as the equity markets or real estate, dropping in value. It’s a reserve currency or safe haven asset class in a crisis, like Gold, Oil, and the US Dollar have been in recent history. But again, as the argument goes, Bitcoin is technologically superior for the reasons mentioned above and those described in this Winkelvoss blog post.
To the latter point, the next test of Bitcoin was always going to be “the next crisis.” Well here we are, and the price of BTC is just under $14k as of this writing, October 29, 2020. This, after being relatively stable at $9–11k for much of the last year. The BTC market is exhibiting some signs of maturity, and is behaving as expected given the real world turbulence, recession, and its rise up the technology adoption S-curve.
Futures aren’t just for pure speculation, they are valuable for hedging
In the Hayes-Roubini debate referenced above, Hayes points out that futures add real value as an instrument for hedging.
In the case of “traditional” commodity futures, companies with risk exposure to commodity price changes will typically hedge this risk using futures. So for example, BP is known for having a sophisticated trading operation. At a basic level, since they sell gasoline, and generally make less money when gas prices go down, they will hedge by buying futures that allow them to make money if the price of gasoline goes down. This way, they offset their potential loss and limit their risk to the business.
Similarly, hedging through futures allows sophisticated traders, including large-dollar players such as funds, to offset some of their risk on crypto positions. Maybe a fund has a big position owning BTC. If they also make a futures bet on the price going down, they limit their risk.
BitMEX’s Arthur Hayes’ bravado
BitMEX’s Arthur Hayes fits the part of the CEO of the hard charging, wild west crypto exchange startup that’s out for arrest. Running the company primarily from Hong Kong it seems, he is a UPenn grad and former Wall Street trader. He comes across as bright and full of bravado.
In the context of this bravado, BitMex’s loose policies and aggressive product offerings do seem a natural extension of his personality.
Watching the Hayes-Roubini debate mentioned above, and some other clips, the interesting thing is that Hayes’ bravado gets dangerously close to the red line of hubris.
He says in the debate, “good luck suing [BitMEX] in the Seychelles.” He goes on to joke that it only cost “a coconut” to bribe the officials of the Seychelles to set up shop there. His general disposition in the debate is that Roubini is a fussy old crank.
The “coconut” quote was included in the indictment papers filed by the CFTC and DOJ. That seems like evidence that his bravado may have caused the US regulators to be even more angry and motivated than they already were.
Regulators, and judges, are people too, and whether we always like it or not, they are prone to be influenced by their emotional response to someone’s behavior.
Maybe he could have dialed it back 10%, but from a story perspective, it’s almost like Hayes saw himself as the lead character of a movement who just wouldn’t back down. There’s definitely an element of that with crypto people — they often feel galvanized by being part of this big new wave, one that stands for both a technological revolution and a libertarian one.
The aftermath: Bitcoin deposits on BitMEX declined 30% in week following indictment; then the 4 indicted executives stepped down
BitMEX was not shut down. But there was a run on the exchange.
From Wednesday, September 30th to Tuesday, October 6th, BTC deposits with BitMEX declined about 30%, according to CoinDesk. The withdrawal run was not surprising given this newly introduced regulatory uncertainty.
Then on October 8th, the 4 indicted executives stepped down from their respective leadership positions, as reported by CoinDesk. Presumably, this was a move seen as necessary to stabilize the company and restore credibility.
The question about if and how governments can regulate crypto is still playing out in real time
The regulation and sovereign governments’ power question is really where the rubber meets the road when it comes to crypto.
It’s an interesting question with all sorts of threads. I wrote about Telegram and their legal situation earlier this year (they are the 2nd largest ICO in history with a $1.7B raise in 2018).
The SEC sued Telegram in 2019. Here is a quote from my above-mentioned article that summarizes the case:
The SEC sued Telegram for selling unregistered securities in October 2019. Telegram maintained they should be exempt from registration under SEC Regulation D, because they were pre-selling shares that weren’t allowed to be resold in a secondary market before the actual public ICO of Gram. The SEC brought evidence that there were in fact commission-based secondary sales.
The case is still playing out. Telegram received their ICO money, but technically the ICO never happened (it never became publicly traded). Right now it seems like US-based investors won’t be able to invest, and will only get a portion of their investment back, while internationals may be able to continue their investment.
With Telegram it was the SEC. This time with BitMEX, it was the CFTC and DOJ. The government enforcement agencies aren’t just sitting on their hands doing nothing.
BitMEX was not shut down. It presumably cleaned up its’ act from a corporate governance standpoint, and the 4 executives had to step down. 3 remain at large, so we’ll see if they are found and what, if any, penalties stick for the persons and company.
But to Roubini’s point about the problems of exchanges not being regulated, plenty of other exchanges have shut down, even just this year. According to the Crypto Wisser Exchange Graveyard, at least 75 exchanged have closed in 2020 alone.
As written by Cointelegraph’s Martin Young:
As least 75 crypto exchanges have closed down due to hacks, scams, or simply disappeared for unknown reasons so far this year.
As the quote suggests, these exchanges, broadly speaking, seem to be poorly run at best, and downright thieves at worst. Regardless, in most if not all of these cases, the exchanges’ clients lost assets as a result of the exchange closing. These are the perils of the unregulated crypto market, and they serve as Exhibit A to Roubini’s case.
Can a single government, even a powerful government like the US, effectively enforce its rules in the crypto space? Will they be able to gain and retain power? When you cut off one head, won’t 2 grow back? If you prevent US investors from participating in an ICO, won’t they just move offshore? We’ll have to wait and see how this plays out. I’m sure we’ll see more stories soon.
