Crypto Central Bank (Conclusion)

Crypto Central Bank (Conclusion)

Derivatives Exchanges and Lender of Last Resort

When crypto derivatives were originally launched, there were many skeptics that derided companies like Bitmex as an unregulated casino. Growth has been explosive however with derivatives volumes hitting $2 trillion during Q1 2020 and growth projections remaining steady through the year. Arguably the most important instrument that is currently traded is the perpetual contract. Created in 2014, BitMEX’s popularity grew immensely and by March of 2020 it handled billions of dollars of trading volume per day with current studies showing that the perpetual contract is critical to Bitcoin’s price discovery.

BitMEX facilitates leveraged trading of Bitcoin, but also guarantees that no trader can lose more than their margin. In traditional markets, this is often not possible. BitMEX achieves this because it acts as the lender of last resort by using two features. First, if a position gets liquidated because the remaining margin is not enough, the Bitmex liquidation engine automatically takes over the position. This liquidation engine that is run by Bitmex tries to close the position at a price favorable enough so that not all the remaining margin gets used. If the liquidation engine successfully exits the position with margin remaining then the margin is deposited into Bitmex’s “insurance fund” (34,678 BTC most recent balance).

The second feature is auto-deleveraging that is used as a last option. If the liquidation engine cannot exit positions profitably and the insurance fund runs low, the auto deleveraging feature will resort to taking money from traders with winning positions to cover losses from losing positions.

Bitmex acts as the lender of last resort in order to support liquidity in an instrument that is crucial to the liquidity and functioning of financial ecosystem in crypto in general. It is no different as the central bank and the overnight lending that they offer for banks in order to meet liquidity requirements. The entire world witnessed the systemic effect that perpetual contracts now have on the entire space, when the selloff was exacerbated by the Bitmex BTC perpetual contracts almost leading to a complete price collapse.

Conclusion

If the crypto networks will eventually fund product fit and gain widescale adoption in the future, it is safe to presume that the crypto financial system will play an even more critical role. Central banking systems all started in a similar fashion which was to maintain currency stability. But after each crisis event and the macro related forces of the particular era, the central bank was forced to play a bigger role in supporting the economy through its policies as the financial system became more complex and became more and more central to the entire economy. If history is an accurate representation of the progression of central banking systems, the crypto central banking likely look more centralized and play an even more critical to the overall functioning of the cryptonetwork economy.

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