Inside the crypto casino

Derivatives based on cryptocurrencies are big business, generating fortunes for the owners of trading venues.

But those exchanges don’t all play by the same rules. Confusingly, the global regulation of crypto derivatives—and of cryptoassets in general—is all over the place.

Some countries propose a ban on all sales of crypto futures, options and forwards to the general public, while neighbouring countries impose no restrictions at all on access to bets of anything up to 100 times the initial deposit outlay.

And that’s all within a supposedly single regulatory area, the European Union.

Although the largest crypto derivatives exchanges are all Asian, Deribit, an exchange based in Amsterdam and set up in 2016, claims to have 10 percent of the global market.

On a recent trading day, it processed over $1bn in volumes, generating anything up to $750k in revenues for the exchange, which is run by 20 people and apparently co-owned by just four.

New Money Review recently obtained an exclusive interview with Marius Jansen, the chief operating officer of the exchange.

New Money Review: Is Deribit regulated and, if so, by whom?

Marius Jansen: At this stage, we are unregulated because the current regulations are not focused on our type of product (derivatives settled in cryptocurrency). As this might change in the future, we are in dialogue with our local regulator in the Netherlands.

[The local regulator is the Authority for the Financial Markets (AFM). The AFM said it didn’t comment on the regulatory status of individual firms, but referred us to its database of licensed institutions. There was no record of Deribit there—New Money Review comment]

New Money Review: How big is Deribit?

Marius Jansen: We are around 20 people and on July 15, for example, we saw over $1bn in trading volumes. We believe we have around a 10 percent share of the overall cryptocurrency derivatives market.

New Money Review: Your clients can take out trading positions of up to 100 times the initial deposit, which incur a very high chance of being stopped out and liquidated, especially given the volatility of cryptocurrencies.

What responsibilities do you feel you have before your clients? Are you worried about consumer protection?

Marius Jansen: Our responsibility is to give customers a good service and to be as clear as possible about our products. I think our average user is more sophisticated than the average spot trader in cryptocurrency. But everyone carries the responsibility not to do stupid things. You can also lose all your money in the casino.

New Money Review: What type of clients you serve?

Marius Jansen: They are mainly institutional.

New Money Review: How can you tell? It’s possible to open an account with you using just an email address.

Marius Jansen: We can see at the back end who our biggest traders are, and we know them. We also perform know-your-customer (KYC) checks with our institutional clients.

New Money Review: What restrictions do you have on who can participate on the platform?

Marius Jansen: We can’t accept clients from a number of countries, including North Korea, Syria and the US.

New Money Review: How can you enforce that rule if someone can just sign up with an email address?

Marius Jansen: We can block their IP address and give them notification they can’t sign up to the exchange. Or if we become aware that someone has tried to get around the rules, we can block their account or stop them closing positions. We can’t give a 100 percent guarantee there is no breach of the rules, but we do our best to minimise the chances of that happening.

New Money Review: What is the overall impact of the cryptocurrency derivatives market on the underlying spot market?

Marius Jansen: It’s difficult to say. Sometimes derivatives help stabilise prices but sometimes they can amplify market moves. A couple of days ago, for example, we had a crash in the ethereum price. Some very big players got liquidated, and this had the effect of sending prices lower still. This move was driven primarily by the derivatives market.

But overall, the greater the variety of trading possibilities, including derivatives, the better it is for price discovery and the overall ecosystem.

New Money Review: You operate an insurance fund to help cover the losses of bankrupt traders. But if the insurance fund gets depleted, the losses from any further bankruptcies are then socialised among the winning traders.

This risk-sharing model differs substantially from traditional derivatives exchanges, which use a central counterparty to guarantee all trades. What do you make of the different approaches to managing risk?

Marius Jansen: In the traditional derivatives markets, you are still on the hook for any losses once your account funds are depleted. Your broker can knock on your door the next day and ask for more money.

We can’t use this model in the cryptocurrency space, since there are a lot of traders you don’t know. So a risk-sharing model that involves the socialisation of losses became popular as a result. It was pioneered by the OKCoin exchange and is now widespread. The insurance fund structure is an extremely important tool for the crypto derivatives market.

Up to now, winning traders on Deribit have always been paid 100 percent of their gains. We haven’t yet had to socialise any losses.

New Money Review: What’s the difference between you and, say, BitMEX? They have made it clear that they have had to socialise losses on occasion in the past.

Marius Jansen: First, we use a different liquidation mechanism. We don’t liquidate a whole position at one go, but do it incrementally, which is less stressful for the market. If trades are liquidated at once, there’s an increased chance of an exchange halting trading or putting trades into a queue.

[On its site, BitMEX tells clients it may queue or even refuse to accept orders in fast market conditions—New Money Review comment]

And we are very clear about what’s in our insurance fund: other exchanges don’t necessarily clarify how much is in their insurance fund by type of contract, nor how much cryptocurrency is allocated for each type of contract, which we do.

New Money Review: When a Deribit client’s position is liquidated as a result of an adverse market move, how much do you as an exchange earn from the liquidation?

Marius Jansen: We earn the normal ‘taker’ fee, usually 7.5 basis points. And an extra 45 basis point fee goes into the insurance fund, not to us.

[The exchange’s fees may have changed: on its site, Deribit says it charges 0.375 percent  (37.5 basis points) for liquidations in its popular perpetual bitcoin contract, of which 0.30 percent goes to the insurance fund and 0.075 percent to Deribit—New Money Review comment]

New Money Review: What differences are there in the way Deribit operates and the way some of the large Asia-based crypto derivatives exchanges operate?

Marius Jansen: I’d say the differences are not so much in operation, more in philosophy. We are a family-run company: I founded Deribit with my brother John.

From day one we’ve been focused on the technology and being an exchange that works very well. I believe we have an advantage over other exchanges in our ability to handle a higher volume of orders and with lower latency. We have several products that we could add in a couple of weeks and which could give us a lot more profit. But we decided we want to invest more in technology first.

New Money Review: What are your firm’s key priorities for the coming years?

Marius Jansen: We want to make sure that if we grow ten times more, we can still offer the same speed and trading experience. But before the end of the year, we want to become the most advanced crypto derivatives exchange in the world: a one-stop shop for all the products you need, including cryptocurrency options, where we are the only exchange in the world.

New Money Review: Any plans to start handling fiat currency?

Marius Jansen: Not for the time being, but we have looked into opening a spot cryptocurrency exchange. However, handling spot trades would require a lot more customer support and would carry its own issues over banking relationships, and so on.

A leading spot exchange like Bitstamp, for example, has 200 employees, while we have around 20. For now, there are still enough growth opportunities for us in the cryptocurrency derivatives market.

But if we do open a spot exchange, it will be because we think we can do it better than the rest.

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