Bye Bye, ConvexityAug 19, 2021
The age of collateralizing derivatives positions with the native asset is coming to an end as traders rapidly shift from coin-margin to cash-margin (stablecoins).
We glossed over this in a previous daily, and the effects of this are profound. For starters, shorts lose their innate hedging and positional convexity. When BTC price goes up, shorts with BTC as collateral have a natural hedge because their margin (spot BTC) goes up. With stable-margin, shorts are naked as they don’t own the BTC they are shorting. Longs on the other hand are exposed to less downside risk when BTC goes down, because they don’t get hit with the double whammy of their derivative position and spot margin going losing value in tandem.
Stablecoins as margin provide a more linear profit/loss curve. And as explained above, this provides more downside protection to longs and less to shorts.
As a side note, this phenomenon explains BitMEX’s market share decline over the last year, since the exchange exclusively supports coin margin (no stablecoin support).