Crypto Exchanges = Glorified Online Casinos

The stock markets in most developed countries is dominated by the institutions and professionals.  You have small pockets of retail dominated flows, especially in speculative small cap names, but overall, institutions are the price makers.  

Cryptos are a whole another world.  Just by the way it trades and the speculative nature of the asset, institutions just don't have a lot of appetite for investing in it.  Also the regulations and limitations put on institutional investors prevent large inflows into the space. 

Due to regulations and the speculative nature of the cryptocurrencies, there are glaring inefficiencies in the market.  Especially the derivatives market.  

Each crypto exchange is like an island, with its own funding rates, spot prices, etc.  One thing I've noticed is that the exchanges with Asian origins, like a Binance, Houbi, Bybit, etc. have much more volume and speculation in the futures and swaps market than the exchanges with Western origins, like a FTX or BitMEX.  You can also see the difference in the funding rate differences between Binance and FTX over the past 30 days.

 

These are 8 hour funding rates, meaning to get an annualized rate, you need to multiply by 3x365 = 1095.  So on average over the last 30 days, to go long BTCUSD as a perpetual swap, on Binance you had to pay an annualized 80.0% rate to those short BTCUSD.  On FTX, that rate was high, but much less at 50.4%.  Similar differences between Binance and FTX are found in funding rates in ETH and XRP derivatives.  

Now these funding rates over the past 30 days are not sustainable, in my view.  Looking at past funding rate data, during less speculative crypto markets, like September/October 2020, the funding rates on Binance from BTCUSD were averaging 0.01%/8hrs, or about 11.0% annualized.  A decent positive carry, but not astronomical like recent times.   

Funding rates are determined by demand for long or short positions in the futures/swaps market.  If the speculators are eagerly looking to go long with leverage, then the funding rate has to go up to entice traders to short to keep the price in line with the spot market.   These high funding rates are a clear sign that there is rampant speculation on the long side with very little regard for the high cost of carry to hold those positions. 

I've also noticed that FTX tends to have slightly lower prices for the cryptos than Binance.  It seems as if the Western based exchanges have more short sellers,  arbitrageurs, and professionals looking to take advantage of these retail distorted markets than the Asian based exchanges.  In other words, there is a lot more dumb money in the Asian based exchanges than the Western based ones.  It just happens that the Asian based exchanges also have most of the volume and open interest.  

So it still seems like the dumb money is vastly outweighing the smart money.  I don't expect that to continue forever.  Eventually the smart money gets bigger, and the dumb money slowly bleeds away.  Just like during the poker boom from 2003 to 2007, terrible players were plentiful in the beginning, but by 2010, 2011, any decent stakes online game were mostly sharks waiting for a few fish to sit down at the table. 

If you think of these cryptos like currencies, it really makes no sense.  They are basically all valued against the dollar, and if you lend out bitcoin, you get anywhere from around 5 to 10% annualized depending on where you lend it.  So its a high yielding currency.  So in that scenario, high yielding currency spot prices should trade at a premium to forward prices vs the dollar, to account for the higher yields.  But in this speculative driven world, bitcoin and all the other cryptos are trading the exact opposite, with spot prices much lower than forward prices.  The contango in that market is steep, anywhere from around 10 to 25% depending on the exchange.  And in the perpetual futures/swaps market, the interest rates are even higher, if you average out the past 90 days. 

The inefficiencies in the market pricing all originate from the lack of sellers in the derivatives market.  There is a large pool of speculators looking to get long with leverage in the cryptos but very few looking to get short.  So what you end up with are very high funding rates for long positions.  And a huge positive carry for holding shorts, especially in the more speculative coins like DOGE and XRP.  

Due to US regulations, US based investors are not allowed to trade in the crypto derivatives market.  Binance and Huobi, the 2 largest exchanges, don't accept US clients for their main site which includes futures and swaps.  This keeps out a huge pool of capital from participating in the market, keeping the prices less efficient than it otherwise would be. 

There are downsides to cryptocurrency trading.  These exchanges, even the biggest ones, are sketchy in comparison to traditional brokerage firms where rules and regulations keep fraud under control.  You have supposedly had hacking incidents, where tens of millions to hundreds of millions worth of bitcoin have been stolen.  I would view those incidents less as hacking and more like outright stealing by insiders.  So these are not safe places to store vast sums of money.  The crypto exchanges are the wild wild west.  They are basically glorified online casinos.  And if you've ever gambled at an online casino, most are scammy beyond belief and probably rigged. 

People often argue whether bitcoin is a currency or a store of wealth.  I view it as neither.  Bitcoin is the most widely accepted casino chip in the crypto world.  Closely followed by tether.  So if you have bitcoin or tether, you can play in the biggest unregulated casino in the world.  Bitcoin is just like casino chips, you need it to play the game, because the game won't take dollars directly.  

If the game of cryptocurrency trading loses popularity, the demand for the chips in play, bitcoin, and tether, will fall accordingly.  That would lead to a lower price for BTCUSD, which in turn would make the game less attractive to play because most people don't like to keep playing games when they lose money.  In the end, it will be mostly the die hard crypto traders that remain, just like at a local casino, where mostly the compulsive gamblers remain late into the night.

I am getting a bit more interested in putting on an SPX short as we get closer to 4200, but we still haven't seen that steep parabolic rise that would be a signal of an impending reversal.  Its probably a positive risk reward to short at SPX 4180, but there is definitely a possibility that there is a stop run above 4200 before it reverses hard and goes back down towards 4000.  I may put on a small short this week and add more if we get that spike higher.