An Analysis of Filecoin Trading Dynamics
In this latest edition of the CoinList Market Update, we take a deeper look at the new kid on the cryptocurrency Top 20 list: Filecoin (FIL).
Several years in the making, Filecoin was for a long time the stuff of legend: a bold vision, a blockchain-based solution to a real problem, a massive amount of capital raised. All the ingredients were there to make the FIL launch one of the most exciting moments of 2020 for crypto watchers.
So what exactly happened at trading launch? What exchanges were first to list? How did FIL spot price discovery happen in the first few hours? How did a nearly 200% arbitrage exist between two serious exchanges? How did the yield curve behave? How are the future markets connecting the dots? All this, and much more, discussed below.
The boldest visions are usually very simple to grasp: Filecoin is a decentralized storage network. Instead of paying Apple or Amazon to use iCloud or AWS, Filecoin promises to turn cloud storage into an open market when storage providers offer space to storage users in a decentralized, transparent and censorship-resistant fashion.
A few details that are important to point out: Filecoin is its own blockchain with its own token, FIL. Simplistically, FIL is used for two main functions on the Filecoin network:
- FIL is a means of payment for users to reward storage providers.
- FIL has to be staked by storage providers as collateral against their pledge to store users’ data. This means that miners scaling their operation will tend to be borrowers of FIL until they have earned enough FIL rewards
The Global Launch of FIL
The question on everyone’s lips on October 15th was: Where would spot FIL list first? And at what level would the price open?
FIL perp markets had been trading for a few months on gate.io and a few weeks prior on OKEx. However, some doubts were expressed by market participants around the predictive power of such instruments from a pricing perspective. A perp is convenient in that you never have to settle it. Its price is anchored to its underlying asset through the funding rate, but without an index reference price the funding rate had to be hard-coded at 0%.
The day is October 15th, 8am PT. Against all odds, Gemini was the first US exchange to open the FIL/USD for trading with an initial price of $30 while perps were trading around $25 on FTX and OKEx. Gemini was the first to the table but the numbers were far from impressive: the exchange recorded only $750k in the first hour of trading. Things only started to get interesting when Asian exchanges opened their books: Huobi opened with an impressive $130 FIL/USD while Gemini was sluggishly rallying towards $45 per FIL. Shortly after, CoinList launched FIL/USD with an opening price of $207.50. Why did Huobi and CoinList open so high while Gemini was in the mid-$40? It is impossible to conclusively point to a single factor, but we can reasonably assume that aggressive buyers were ready to lift offers on Huobi and CoinList: they had deposited USD, they had their account and API set up and ready to go because they expect FIL to launch on those exchanges. Clearly, Gemini was not on their radar at the time.
This should still give you pause. Gemini and Huobi were both trading spot FIL, so how can a nearly 200% arbitrage exist between two serious exchanges? In trading, opportunities are usually found where there are inefficiencies and frictions. And frictions there were: the Filecoin blockchain mainnet only happened a couple of hours before trading opened on Gemini. To stay on the safe side, FIL custodians required an abnormally large amount of confirmations before confirming any FIL deposits. In practice, this meant that moving FIL from Gemini to Huobi would take about 2 hours. In essence, unless you had the foresight to receive your FIL distribution directly on Huobi, the arb was impossible to trade.
The addition of Binance to the mix of exchanges started to tip the scales towards spot price convergence at around $50. In summary, after a few hours of trading, Kraken, Gemini, Huobi, CoinList and Binance all had spot FIL a few pennies away from each other. However, at the same moment, FIL futures were trading nearly 50% lower, between $25 and $30. Why would that be?
To understand the FIL spot vs. futures price dislocation, one first has to go back to the distribution profile of FIL.
FIL Vesting Schedule
Three years ago, FIL SAFTs were sold to investors with the understanding that the tokens would not convert all at once on mainnet day, but rather would vest linearly according to a predetermined schedule going from six months to three years. If you had invested in the six-month SAFT, you would only receive approximately 1/180th of your total FIL distribution on October 15th. Now let’s say FIL @ $50 means a 20x return on your SAFT investment. Selling 1/180th, or 0.55%, of your position surely does not feel enough. But how can you sell something you do not have in your crypto wallet?
Technically, the cleanest way to do so is to borrow FIL in order to short it. In practice, that is very hard to do. The FIL lending market was still nascent in October, and only large crypto institutions would be able to get access to it. More on that later.
The alternative is to use derivatives instruments.
If you are a keen reader of the Market Update, you are already familiar with the two main types of linear derivatives in crypto: futures and perpetual swaps. In a nutshell, derivatives are neat financial instruments that allow traders to take a long or short position into an underlying asset (in this case, FIL) without having to ever take delivery of such asset. A fairly crucial feature for the problem at hand here: FIL derivatives allow you to go short FIL without having to actually own that FIL. We will limit our analysis on FIL futures to keep things concise.
For the sophisticated FIL holder, selling FIL futures became the game in town. The impact on pricing was immediate. The graph below displays FIL spot price (in blue) and FIL futures price (in red and green candles):
Notice how in the first hour of trading, the blue line and candles overlap. This means futures and spot prices are roughly equal.However, futures completely fail to follow spot when the latter rallies towards $70. This means a lot more selling pressure on the futures than on spot. Let’s presume this was due to FIL holders selling into the futures in size to hedge their unvested FIL position. Two hours into the FIL listing, the basis (= difference between spot and futures price) got to around 40%.
The dislocation was quickly noticed by cash-and-carry traders who became focused on taking the other side of that trade: buy FIL futures, sell FIL spot, carry the trade until futures expiry and collect the ~40% basis. To do so, they needed to figure out a way to sell FIL they do not have, i.e. borrow FIL, and fast.
This gave rise to a wildly volatile lending market virtually overnight.
FIL Lending and Borrowing
Opportunities like the FIL cash-and-carry trade are the holy grail of any crypto trading firm. The trade is virtually risk-free (bar a derivatives exchange shutdown) provided you have access to both legs of the trade until the futures expiry date. That’s where FIL borrowing turned from a miner-driven market to a trader-driven market.
Intuitively, the wider the basis, the higher the APY basis traders should be ready to pay to borrow FIL and capture such basis. The Fair Value of that APY is roughly equivalent to the annualized PnL captured on that trade. We have:
- Basis = 40%
- Trade date: October 15th
- Futures expiry date = December 25th
- Number of days = 71
- Annualized PnL =
- FV of FIL APY =
- 40% x 365 / 71 = 205%
This means that the cash-and carry trade was profitable as long as traders were able to borrow FIL for less than 205% APY. That is how FIL became the highest yielding cryptoasset for a time.
As traders executed the cash-and-carry trade, futures were being bought while spot was being sold. Slowly but surely the two converged:
As prices converged, the trade became too low margin for cash-and-carry traders to care about it. Little by little, they exited the FIL borrowing market. With this demand gone, the FIL APY quickly fell back down to earth.
In conclusion, the FIL launch gave us a wonderful demonstration of the “invisible hand” at play: how frictions in one market creates an opportunity in another, and how the broad availability of a diverse set of financial primitives (spot, futures, loans in this example) usually allow markets to reach equilibrium more efficiently.
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