Ex-Citi Trader's Bitcoin Exchange Skirts Currency Curbs

Arthur Hayes

Arthur Hayes

Photographer: Jerome Favre/Bloomberg
  • Bitcoin Mercantile Exchange has already turned profitable
  • Exchange lets investors take synthetic positions in stocks

It was after Arthur Hayes got laid off from Citigroup Inc. in 2013 that he stumbled across one of the simplest ways to make money he’d ever seen. He was living in Hong Kong and saw the price of bitcoin across the China border was much higher. He hopped on a bus, opened a China account and started buying low in one market and selling high in the other. “It was too easy,” he says.

The price discrepancy eventually disappeared, but it gave him an idea: He could make more money if he gave others the means to take advantage of similar trading opportunities between countries. So in early 2014, he started the Bitcoin Mercantile Exchange with two friends. The mission is to create an institution like the Chicago Mercantile Exchange that will let people use the cryptocurrency to bet on securities not easily accessible in their home markets, especially China. 

QuickTake Bitcoin and the Blockchain

China restricts the ability of companies and individuals to exchange their yuan for other currencies, part of the government’s strategy for managing its economy. That can make it complicated and expensive for citizens to invest in overseas securities, while foreign investors face restrictions in trading China stocks. Hayes’ idea is to let Chinese investors use bitcoin to buy synthetic versions of offshore stocks that would normally be off-limits, like Apple or Facebook. Conversely, foreign investors could effectively short a basket of the country’s shares not typically exposed to such strategies. 

“Our goal is to let anyone bet on anything at any time,” says Hayes, an American who is now 30 and works in Hong Kong.

BitMEX doesn’t sell bitcoin itself. Rather, traders go to sites like Coinbase or Kraken to exchange their money for the cryptocurrency. Then, they can open an account with BitMEX, deposit the bitcoin and use that money to trade. Investors don’t buy stocks themselves, rather they pay in bitcoin for derivatives, or contracts designed to simulate stocks or indexes. Any profits or losses are calculated in the customer’s BitMEX account, and they can withdraw the proceeds to convert back to cash when they choose.

Hayes and his co-founders face enormous challenges in making their vision a reality. China has closed loopholes its citizens use to move money abroad and it could do the same with bitcoin. BitMEX doesn’t have a license to market to Chinese investors and is relying on the government’s so-far permissive approach to continue. At the same time, the cryptocurrency is losing some appeal because of price volatility and infighting within the bitcoin community. There are also dozens of alternative virtual currency exchanges, including some like Beijing-based BTCC that have larger trading volumes.

For more on conflict within the bitcoin community, click here.

Still, BitMEX is making progress, aided by the size of the Chinese market and Hayes’ experience in designing complex financial contracts. So far, 5,800 users have traded $760 million on the exchange. The company is already profitable, a rarity among startups. Hayes also said he’s not wedded to bitcoin and would let people use other digital currencies if they prefer.

“BitMEX has established itself as one of the early derivatives exchanges in cryptocurrency and is benefiting from the proximity to the Chinese market as well as founder Arthur Hayes’ experience in derivative trading,” said Gil Luria, head of technology research at Wedbush Securities Inc.

Last month, BitMEX took first place among 475 startups at a competition in Singapore hosted by the technology blog Tech in Asia. Hayes and his partners are now seeking to raise $2 million to expand the financial products they can offer. They want a partner who can help distribute their products to retail Chinese clients or an established derivatives exchange to give them access to institutional traders. “Profitability gives us flexibility in who and how we take funding,” said Hays, adding they have turned down offers.

William Bao Bean, a China venture investor, said BitMEX’s timing is fortuitous. Investors in the country are looking to diversify abroad as the economy slows and domestic investments become more unpredictable. “There are many people who want to see their money outside of China right now,” said Bean, a former Deutsche Bank investment banker who runs a program for startups called Chinaccelerator.

Hong Kong School

Hayes was born in Buffalo, New York and grew up in the Bloomfield Hills suburb of Detroit. His mother was a manager at General Motors Co. and his father worked on the factory floor at Delphi Automotive Plc. He went to the University of Pennsylvania’s Wharton School and studied finance, economics and Chinese. He ended up in Hong Kong by accident. He wanted to go to an immersion program in Shanghai his junior year of college, but his Mandarin wasn’t good enough. Instead, he spent the year at the Hong Kong University of Science and Technology. “I loved it so much I said I would do whatever I could to get back,” he says.

He was clear about his priorities as he hunted for a full-time job. “I wanted to make money,” he says. “I was thinking about China even in school because I wanted to find an edge. You’re not going to be Warren Buffett by going to be an analyst at JP Morgan.”

Hayes landed an internship at Deutsche Bank and learned about trading. He worked with derivatives -- options and futures on other securities -- and exchange-traded funds, just as that business was surging. He moved to Citigroup in 2011 and specialized in exchange-traded funds. He lost his job amid 11,000 layoffs at the bank.

When he started BitMEX, Hayes recruited partners with technology expertise. Ben Delo, an Oxford University grad who developed software for high frequency traders, is building the startup’s trading platform. Sam Reed, a Web developer based in Milwaukee, works as the site’s chief technology officer from Wisconsin.

They’re part of a rush of entrepreneurs to greater China as the country has become the center of the bitcoin world. Ninety percent of the cryptocurrency’s exchange volume is in Chinese yuan, according to bitcoincharts.com. The country also accounts for a majority of bitcoin mining, the complex computing process for extracting new currency.

China is a growing source of funds for foreign entrepreneurs too. Hayes and Delo participated in a three-month boot camp run by Chinaccelerator that helps entrepreneurs build their businesses and refine pitches to venture capitalists. More than half of the startups have foreigners among their top executives.

BitMEX thought the boot camp would help them localize their English-language platform. But it turned out, language wasn’t the problem. They found what Chinese investors wanted was the ability to borrow - a lot. BitMEX began allowing people to borrow as much as $100 for every $1 they have in capital -- five times more than some competitors offer. Trading volume has surged.

The result is gains and losses are magnified. For example, with that leverage, you could put down $1,000 and buy the bitcoin equivalent of $100,000 worth of Facebook stock. If the stock goes up 5 percent, you’ll make five times your money. If it goes down 5 percent, you’ll lose your initial $1,000 and $4,000 more.

Hayes and his team say they have a margin-call process to keep traders from losing more than they have. They monitor everyone’s portfolio in real time with software called KDB+, the same technology used at high-frequency trading firms. When someone fails to meet margin requirements, their account is liquidated immediately. If someone’s losses exceed their exchange balance, by contract everyone else who made money has to help cover the losses. Hayes says this works because the exchange is a zero-sum market, matching trades between investors: “Everyone’s gain is someone else’s loss,” he said. “We’re just trading a contract between two parties. One side makes and another side loses, at all times.”

Leonhard Weese, president of the Bitcoin Association of Hong Kong, said traders do lose significant sums on the exchange, but it has shown it can withstand such events. “I think quite a lot goes wrong for the people gambling on BitMEX,” said Weese, who doesn’t trade himself. “But they probably consider it more of a casino than a hedging platform.”

So far, BitMEX is running a limited experiment. Traders can bet on the price of bitcoin, other virtual currencies, market volatility and an index of China’s 50 biggest public companies. Hayes’ goal is to create products so people can bet on real-world currencies, bonds, stock indexes and individual securities. The Chicago Mercantile Exchange, their inspiration, allows traders to wager on everything from European weather to Singaporean gasoline and Latin American currencies. “The thing about Arthur is that he knows what he’s doing; he’s an ex-futures trader,” said Joseph Wang, a former coder at JPMorgan Chase & Co. who uses BitMEX to hedge currency risk.

Still, Hayes is realistic enough to know he is far from his goal. He needs to raise money to expand to see whether demand for his products will continue. “I had this idea, but as anything in tech, it’s about execution -- not just the idea,” he said.

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