Review: Bitfinex’s “Mysterious Big Short”: What are the trading principles and motivations?

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Wu Shuo Author | Liu Quankai

Editor of this issue | Colin Wu

A mysterious whale has appeared on Bitfinex. It may be a large investor or an institution. Whenever it appears, the market is in a state of panic. According to Datamish data, this mysterious whale has appeared four times in the past six months.

The first one started around May 17, with a maximum of 11,469 BTC lent out. Two days later, the “May 19 incident” occurred in the cryptocurrency circle, with BTC falling by more than 30% on that day. Then, the BTC lent out was returned on May 19.

The second time started around June 6, and this time span was the longest. On June 15, the highest BTC was lent out, 25,053 BTC. On June 22, most of the BTC borrowed was returned. On June 22, BTC fell below the 30,000 mark for the second time after the "May 19 incident";

The third one started around June 24, with the shortest time span and the largest amount of borrowed coins, reaching 25,328 BTC on June 25, a single-day drop of nearly 10% on June 25;

The fourth time started around July 7, and the peak occurred on July 15 with a total of 16,788 BTC. As of July 20, all BTC had not been returned.

Because Datamish data cannot distinguish between entities, a small portion of the BTC lending volume described above is lent by retail investors other than whales. The amount lent by retail investors is small and has little impact on market prices, so it is combined with the whale lending volume for consideration.

(Data source: Datamish)

Trading Principles

In simple terms, the profit-making methods of whales on Bitfinex are similar to leveraged trading or margin trading on exchanges, which is also called Margin trading on Bitfinex, but is different from contract trading. Leveraged trading is a way of borrowing coins on the exchange platform to achieve over-allocation of assets in the spot market, including transaction fees and leveraged borrowing rates, while contract trading does not require borrowing coins in the market to conduct leverage operations. Generally speaking, the leverage multiples allowed by contract trading are much higher than those of leverage trading.

Therefore, in leveraged trading, if investors believe that the price of BTC will rise, they will borrow USD to go long; if they believe that the price of BTC will fall, they will borrow BTC to go short.

On Bitfinex, generally speaking, investors are allowed to use up to 3 times the leverage of the assets in their accounts. That is, if there is 1000U in the leverage trading account, then the maximum allowed balance of tradable assets is 3000U, which can be a long position in USD or a short position in BTC.

If the BTC price is expected to rise in the future, investors will use the USD value they hold as margin, borrow up to 3*USD to buy BTC, and sell it after the BTC price rises. They will then return 3*USD and the generated interest, minus the transaction fee, and the rest is the profit after the long operation;

Similarly, if it is predicted that the BTC price will fall in the future, investors will use the USD they hold as margin, borrow BTC worth up to 3*USD, and then sell it. After the BTC price falls, they will buy it back and return the BTC worth 3*USD and the generated interest. After deducting the transaction fees, the rest is the profit after the short operation.

Leveraged trading is a good way to increase profits. It can magnify your own assets, make a small bet for a big gain, and achieve higher returns. However, you also need to bear the risk of facing a large loss. In addition to transaction fees and interest, you also need to consider the margin factor. If the loss reaches a certain level, there will be a margin call. If the loss is too large, the position will be liquidated. The maintenance margin rate on Bitfinex is 15%. Considering the transaction fee and interest factors, about 50%-55% of the loss margin will trigger a forced liquidation.

Investors use their 10000U as margin for leveraged trading, corresponding to the maximum leverage of 3 times, and can use 30000u. Assuming the current BTC price is 10000U, investors can buy 30000/10000=3 BTC. The exchange stipulates a maintenance margin rate of 15%, that is, 30000*15%=4500u. The maximum loss allowed is 10000-4500=5500u, and the margin loss ratio is 5500/10000=55%. When the margin loses 55%, the position will be forced to close, that is, the position will be blown up. If transaction fees and currency interest are taken into account, the value ratio will be lower.

Trading motivations and impacts

Similar to contracts, when prices change too drastically, leveraged trading will also experience squeezing and stampeding, leading to panic closing of positions to protect part of the principal, which may further depress prices. Therefore, to hold a leveraged position, investors must have a strong belief in the correctness of their judgment of the market direction.

So where does the strong confidence of Bitfinex whales come from? There are mainly the following voices in the market.

1. Know the inside information of bad news in advance

The timing of the first two borrowings was quite interesting. The borrowing began on May 17, and on May 18, the three major domestic financial associations jointly announced that financial and payment institutions were not allowed to conduct virtual currency-related businesses. As the negative news spread to both China and abroad, the BTC price plummeted on May 19. On June 21, the central bank interviewed domestic major banks and financial institutions such as Alipay on the issue of virtual currency trading speculation, and on June 22, the price fell below the 30,000 mark again. From the point of view of time, these two major domestic negative news appeared during the whale's two borrowings. Many investors believe that the Bitfinex whale knew the domestic policy news in advance, and even believed that he was Chinese.

2. Negative news may come at any time, creating a lot of panic through borrowing money

The Bitfinex whale does not know the specific time when the policy will come, but it may be very familiar with relevant domestic and foreign policies and have superb insight into market sentiment and investor psychology. The amount of the first loan was the smallest, but the negative impact of the policy was the strongest. If the insider information was known in advance, the amount of the loan should be the largest; and the second loan span was very long. If the insider information was known, it would not have spanned nearly a week, because the interest on the currency was very expensive. This shows that the whale does not actually know the specific implementation time of the policy, but with his insight into the market and understanding of domestic and foreign policies, he made a loan layout in advance and made a profit when the market fell. In addition, when his operations gradually became known, every subsequent operation would cause panic in the market. Even if there was no negative news, investors might mistakenly believe that there was a negative policy from his loan operations, which had a negative impact on market sentiment.

3. Have strong technical analysis ability and use borrowed currency to boost the trend

The Bitfinex whales may not have considered policy factors too much when borrowing coins. They may have a high level of technical knowledge of BTC and are very confident that the "public" operation will be successful. They analyzed potential factors such as market cycles, on-chain indicators, contract options, and market sentiment and concluded that the market may already be in a bearish state, and combined borrowing coins to help further suppress market prices.

After many times of borrowing coins to short sell, Bitfinex whales have been "targeted" by more investors, and the subsequent operations may not be as smooth as before. As ordinary investors, while watching the whales' operations, you should remain rational enough and not be troubled by their operations.