In a recent blog post released by BitMEX Research, they have decided to explain why the BitMEX insurance fund is needed and how it operates. According to the report, crypto platforms that offer leverage have some challenges that other firms do not have.
The first thing that they mention is that when investors trade on derivatives exchanges such as BitMEX, users are not trading against the platform. BitMEX is just a company that allows individuals to exchange derivatives contracts with other third parties.
Don’t hate, appreciate the BitMEX insurance fund. https://t.co/fIba5Y085u
— Arthur Hayes (@CryptoHayes) February 11, 2019
As the exchange explains, the combination of offering both leverage and the ability for traders to trade against each other implies that winners might not receive the profits they expect. Because of this leverage, losers may not have enough margin in their positions and pay the winners.
There are some traditional exchanges such as the Chicago Mercantile Exchange (CME) that do not have this problem. In these platforms, there are even five layers of protection that allow winners to receive their expected profits.
At the moment, CME is the largest derivatives exchange around the world. It manages an annual notional trading volume of over one quadrillion dollars. The company has different safeguards and insurance that provide protection in the event a clearing member defaults.
BitMEX explains that the platform cannot offer the same protections to winning traders as traditional exchanges such as the CME.
On the matter, they wrote:
“Cryptocurrency is a retail-driven market and customers expect direct access to the platform. At the same time, crypto-trading platforms offer the ability to cap the downside exposure which is attractive for retail clients, therefore crypto-exchanges do not hunt down clients and demand payments from those with negative account balances.”
They went on explaining that platforms such as BitMEX offer an attractive proposition to clients: a capped downside and unlimited upside on a highly volatile asset. However, traders have to pay a price for this service because there might not be enough funds in the system to pay winners what they expect.
In order to solve this problem, BitMEX created an insurance fund system that makes sure that winners receive their expected profits. Unlike traditional markets, profit and loss do not reflect the actual price their position was closed.
The insurance fund is used to ensure that the winning traders receive their expected profits. Depending on how the market evolves, the insurance fund could grow or fall. At the moment, the BitMEX Insurance Fund has 21,000 BTC, close to $70 million. This is just 0.007% of BitMEX’s notional annual trading volume.
BitMEX Research informs that although they have 0.1% of all the Bitcoin supply, BitMEX is not able to offer the same robust guarantees to winning traders as other traditional trading platforms. Despite the fact that the fund has already reached a healthy size, it may not be large enough to give traders the confidence they need in this volatile crypto market.
This is why Arthur Hayes, the co-founder, and CEO of BitMEX says that users shouldn’t hate but appreciate the bitMEX insurance fund.