Welcome to the Crypto Corner of TT’s Trade Talk blog. It’s been a quiet year for the Corner because we’ve been mostly heads-down focusing on building out our crypto offering on TT. And the market is quickly and quietly maturing, so there’s an element of “business as usual” forming around us.
One of the crypto trends that continued from 2018 into 2019 has been the growth and popularity of crypto derivatives exchanges around the world. Many of these exchanges do not offer service to individuals in the U.S. Their products come in many different shapes and flavors; there are futures based on cash indices, there are perpetual swaps, there are physically settled futures and there are options. They trade in different minimum quantities of bitcoin and notionals, each has its own leverage levels and customer profiles, and each typically caters to different regions of the world. In light of all this product diversification, there are abundant relative value trading opportunities for active traders because these derivative products are all very correlated, but not perfectly fungible, like spot. In fact, the derivatives take the FUN out of fungible and run with it!
One of the recent derivatives exchange success stories is CoinFLEX. CoinFLEX has the distinction of being the original physically deliverable crypto futures exchange. It operates out of Asia and does not take U.S. customers, and the exchange had an interesting journey to where it is today. For that reason, I thought it would be great to get some snap responses from CEO Mark Lamb about CoinFLEX today in a “5 Questions”-style interview.
I’ll start by reminding readers and stating that TT is a technology partner and equity owner in CoinFLEX. With that out of the way, Mark, can you describe what it was like putting together the final pieces before your April 2019 launch?
Mark: CoinFLEX, as with any futures exchange, is a complex business and requires many different parts to be completely spot on. Custody, margining, servicing clients, etc. all had to be perfect before launch. Fortunately we have been running exchanges longer than almost anyone in the space, so we are experienced with these challenges.
Trading Technologies’ platform and client base so far have been invaluable with many of our $10M+ per day customers coming from TT’s global/non-U.S. institutional client base. For the futures industry, tools like the Autospreader®, ADL®, bracket orders and MD Trader® are extremely important tools, and being able to trade CoinFLEX through TT makes a huge difference.
We have grown from $0 to $500M a day in less than six months, and this is due to the years and decades of preparation in running exchanges, managing derivatives risk and building trading platforms.
I described in my opening all the different derivatives products in the market. I don’t think people who read this blog need to have physically delivered futures defined, but can you tell us why you think the market needed your product?
Mark: Ultimately for whale traders, large position holders and regular folks with small positions in and out of the market every day, basis risk and manipulation risk matters. That risk is extreme on cash settled futures exchanges and mostly eliminated in physical futures. For building out futures into a proper borrowing and lending trade and business, cash settled futures are useless and physical futures are the only thing that work.
I think ICE agreed with you on the “why” since they’ve launched their own bitcoin instruments based on being able to take delivery into spot. How can you keep an edge against a global competitor that has unlimited resources?
Mark: We have a single focus and less overhead, so we can be more nimble and out-innovate exchanges like ICE. Coinflex launched with four deliverable assets, ICE launched with just one. We’ve listed pre-ICO coins, or initial futures offerings (IFOs), and we have an exchange token that is fun to trade. Plus, myself and the team interact directly with our customers and community in our Telegram channel and other chats, and those users provide actionable feedback that gets rolled out as functionality or new product.
Plus, ICE is primarily focused on the U.S. market, which is 3% of the global population, while we focus on Asia, which is the majority of the global population. The benefit of being offshore is being politically and jurisdictionally neutral. We believe that the same way the biggest companies in the world today (Apple, Google, Amazon, etc.) are jurisdictionally optimized and are not heavily regulated, the biggest crypto-trading-oriented exchanges should be similar. It results in the best quality of service for the largest number of customers worldwide.
In a word, trading on CoinFLEX is a more enjoyable experience than traditional exchanges, and we work and are open 24/7 to keep it that way!
Each exchange has its incentives or perks to encourage trading. Some exchanges pay makers for every trade, some do aggressive affiliate programs, and others pay a healthy monthly stipend. While CoinFLEX has started a stipend program to grow liquidity horizontally across more instruments, your real differentiator has been the “trade-driven mining” or issuance of your exchange token, FLEX, on a pro-rata volume basis for taker-trades. Can you talk about the basic structure of the program, how trade-driven mining works, and the influence of game theory on the aggressiveness of the taker-trading activity in your market?
Mark: Anyone who has built an exchange knows that it is almost impossible to attract traders and firms away from the exchanges where they already trade. It is not enough to have a slightly better contract or interface or regulatory license. Everything must be an order of magnitude better, and even then, the early market makers and takers will want to get paid.
We looked at the incentive programs of BATS in the equities world and some Chinese spot exchanges and created “FLEX Coin,” a coin that is paid out to “takers” of liquidity on the platform, based on their taker volume out of the overall volume for that day. Many were expecting this to be only going to market makers, but our thinking was that ultimately the one crossing spread and causing a trade to occur is the taker, and the ultimate goal of any exchange is to have real, fee-paying volume. So we pay takers FLEX, and as a result, lots of taking activity happens, which typically ends up being profitable for the makers on the other side.
Long story short, when we introduced this, spreads tightened from $5 on average to a little over $1 on average, and liquidity started building up and stacking in the order book. On top of that, we launched a $250-500K per month (split between 10 firms) incentive program with a bonus payout if we beat BitMEX by the end of the year. This combination has turbocharged the exchange’s activity and has led us to become the cheapest venue (fees+spread) to trade less than 5 BTC. Our goal is to become the most liquid for any size, and we believe these incentive mechanisms will help drive that.
With regard to the last part of your question about what determines the aggressiveness of taker-traders, or “miners.” This is the part that’s really fascinating…basically, miners assess the volume on the session, the price of FLEX, the daily issuance amount and the activity in the market, such as the bid/ask widths, to determine what kind of “edge” they’re willing to give up to mine. And it changes from day to day! One day a trader could decide to be a market-maker, the next it may make more sense to primarily be a taker. This dynamic is part of what makes trading on CoinFLEX fun!
You’ve built a strong ecosystem now that includes both aggressive market makers and market takers. What’s next?
Mark: We are aggressively hiring for technology roles at the moment to improve, refine and build out every aspect of the product. Three big things we are excited about are upcoming redesigns of the existing interface, a relaunched crypto-native trading interface and a lending product. The lending product is really exciting because it is a synthetic loan, a basis trade, and creates volume in both spot and futures markets by bringing passive capital that is not in the market now into the market.
Beyond that, we plan to list derivatives on more cryptocurrencies as well as launch options and other forms of derivatives. We think this will result in us becoming the largest derivatives exchange in the world.