Derivatives World comments

Was at the Derivatives World conference in the Renaissance Hotel today.  The food was good and the presentations were really nice.  The people that were attending were all financial intermediaries, but they were different types of financial intermediaries.  From exchanges, to algo traders, to asset managers, to sales and marketing people.  Since I spend most of my time thinking about blockchain and cryptocurrency, it was fascinating to be in a place where no one was talking or much thinking about these things.  The feeling I have is to that of going to a farm in the middle of nowhere, a few years before someone runs a railroad or a freeway through the area.  Things are going to change, and seeing out little blockchain and cryptocurrency was an active area of discussion made me excited because I can see how the technology is going to revolutionize things.

So today was “China Day.”  There was a panel on investments for Chinese looking for investments overseas.  One person made the good point that a lot of the pressure to move capital overseas has to do with the lack of a currency futures market within China.  This is a good point, but I realized that someone could take the USD and CNY bitcoin futures that exist in bitmex and okcoin today, and create a synthetic USDCNY future that is tradeable from within China.

Everyone in the panel was talking about how payments was the big headache.  However, it turns out that the people in the conference were the wrong people to pitch a solution to the headache.  The thing about asset managers is that while they are looking and actually managing money for Mainland Chinese clients, they are legally prohibited from helping their clients move money overseas.  So they don’t.  The client has to figure out how to move the money out, and once the money magically appears across the border, it’s only then that the asset managers can touch it.

There’s also a cost-benefit issue.

A lot of the people at derivatives world are servicing either really, really rich people, big corporations, or institutions.  If you are an individual moving USD 2 million, that’s “small change” and it’s likely that the Chinese government won’t be annoyed if you move the money through unofficial channels.  However, if you are moving USD 10 million or more, you are no longer under the radar, and especially if you are a bank, you have to move the money through official channels.

Conversely, the cost of going through official changes changes a lot once you are dealing with larger sums of money.  If you are just moving USD 2 million, there is a good chance that your request to move money across the border will get ignored.  However, it turns out that if you are a big state-owned enterprise that wants to move USD 30 million to the United States in order to invest in something, the paperwork is the same as moving USD 2 million, and with larger sums and more important actors, it’s likely that you will get the attention of the authorities and they will approval the transfer.

So the reason is that even though payments is a huge problem, the people in the conference aren’t interested in the solutions I have to move money.  Their clients would be, but it would be legal mess for the people involved to even mention that I exist.  So the thing to do is for me to blog loudly.

But there is another use case which bitcoin might be useful……

One of the participants mentioned that they ran into a common problem.  You have a Chinese investor that is trading something overseas on the margin.  They get a margin call.  At that point they have a big headache since they can’t move money very quickly.  All of the standard ways of moving money take about a week, which means that they can’t meet a margin call even if they have the funds in CNY.

Bitcoin is the perfect solution to this problem.  They can hold margin reserve in bitcoin, and use bitcoin futures to hedge the bitcoin.  Since they are already traders, they should know how to do this.  If they need to post margin, then the sell the bitcoin at the exchange.

Now here is where it gets interesting…..

Once you sell the bitcoin at the exchange, then it still takes two to three days to wire the money to the broker.  However, lets suppose that the broker is part of a bank at which the exchange has bank accounts.  The person posting the margin sends the bitcoin to an exchange and sells the bitcoin.  If it turns out that the exchange has accounts in the bank that the broker is works at, then the exchange can very quickly (and possibly within one business day) transfer the proceeds from the exchanges accounts to the brokers margin account, and the person can post the required margin.

Now for this to happen, what you need is an open minded bank which already has accounts for bitcoin brokers, and is willing to work with the brokers.  Note that there are no “real” KYC/AML issues or regulatory issues, since the bank does not touch any of the bitcoin.  You also need a way for someone to explain the process to the traders.  The bank can’t do it because the bank can’t market external services without going through regulatory hell.  The exchanges can mention this, but they need to find the traders.

So at that point you have more blog posts and messages in bottles. 🙂 🙂 🙂

One final thing is that it’s interesting how much of the financial industry looks like people in a dark room running into each other.  Even within the Chinese financial industry, there is a pretty clear split between “traditional finance” which looks a lot like Western traditional banks, and “new internet finance” and the two groups are not talking to each other.  What’s more, few people at the conference were aware of the stuff that was happening in Ukraine or Switzerland.  It’s not that anyone was particularly blind, but it’s because you have a job to do, you are very, very busy doing that job, and that leaves very little time to think about future strategy.  So one thing that I got a strong feeling of is that all of the banks have “digital strategy” or “digital transformation” teams, but those teams are not engaged with the rest of the bank.

So the impression that I have is that one day about three years from now, the banks will be reacting to the new technology in much the same way that Detroit discovered that Japanese cars existed in the early-1970’s.  The “digital strategy” people won’t be surprised, but a lot of other people might be.

One final thing. People in Wall Street tends to be cynical and jaded unlike people in Silicon Valley.  There are so many people talking about the end of the world, and revolution that no one really has time to think about these things. People in Wall Street talk about money rather than ideas, which means that they will ignore until you show that you can make money from something and then everyone listens.

So over the next few months, what my task will be is to put some of the stuff that I’m working on into “making money” mode.