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BitMEX founder: 5 strategies for NFT trading

Arthur Hayes

21-09-04 10:46

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BitMEX founder: What to fear from the coming of JPEG? Top 5 NFT Trading Strategies

Original article by Arthur Hayes, BitMEX

Yangz, the way of Defi

A real trader will make a market in anything.

1. Story time

As many regular readers know, I joined Deutsche Bank's Hong Kong internship programme in the summer of 2007, rotating on the equity derivatives sales desk. It was a time when trading floors were awakened and interns were banned from demeaning activities such as preparing brunch for others.

[But] your only value as an intern is to follow orders and buy breakfast, lunch and mid-afternoon snacks for the people at the table. In return, the professionals will answer your questions about their daily work. Twenty salespeople work on desks. The other intern and I (who are still good friends) spent every day in the hot, humid summer in Hong Kong, shopping for nutrients for our hosts and wearing business casual clothes.

Every week, every salesperson makes a deposit with me, but I deduct their food costs from it. I keep a fairly detailed spreadsheet of what everyone ordered, the date and the amount.

These practices were standard, but as an enterprising bankruptcy intern, I tried to make a profit out of my role as food warden. I charge a fairly high price difference on each order, which makes me a few hundred dollars a week. Don't consider my behavior shameful, know that everyone around the table knew what I was doing and tacitly approved of it. Games respect games.

In the past two weeks, I have weighed in on the philosophical underpinning of the NFT craze. Today's article focuses on different, simple emerging trading strategies. Regardless of the intrinsic normative value of NFT, consider that tens of thousands of ETH and BTC's change hands each month in the NFT market. As cryptocurrency traders, we must participate to avoid leaving money on the table. Similar to the story above, are you willing to use any opportunity to your advantage? While this will not be an exhaustive in-depth study of the NFT trading market microstructure, it is hoped that this will serve as a launching pad for more research to produce Alpha trading strategies.

2. Art market in the physical world

Analogue art is very expensive to deal with, because agents charge large amounts of difference all the way from the creator to the collector. But these fees are necessary to create an environment through huge costs in which the rich are willing to spend money on things that are essentially useless.

Galleries are the first line on the gravy train. They are trying to find the next hot topic. Galleries are like trading platforms, cultivating a roster of wealthy patrons and securing exclusive distribution deals with artists they believe will resonate with collectors. For this service, the gallery charges a hefty price difference in the form of a double-digit percentage markup on the artwork. On the face of it, this difference may seem staggering, but galleries are paying the real cost. The gallery must pay rent to operate a luxurious, white-walled space in the prime rental district of New York, London, Hong Kong, Shanghai, Paris, Tokyo and other financial capitals of the world. Galleries must hold exhibitions and offer expensive drinks and food for free to attract potential buyers into the space. Finally, galleries must cut back on their sales staff. You know, it's common for salespeople to get commissions of 10 to 20 percent. And that's the main market.

Once in the hands of the "right" collector, the real fun begins. Galleries and collectors work together to create the impression that the artist's work is worth having. They go to great lengths to get their work displayed in museums and exhibitions around the world to create the lure of quality. Collectors who change hands quickly are devalued for the obvious reason that it is too "commercial" to change hands too quickly or too often. Art is not a mass market item that can be bought and sold. It is priceless, accessible to many but owned by only a few enlightened and wealthy people. Essentially, the expectation is that once you buy something in the primary market, you hold on to it for a while. Quick liquidity is almost impossible, and trying to create a true market acts as a brake on prices.

Auction houses like Christie's and Sotheby's charge collectors a pound of canvas when they sell works among themselves, and typically take 20% of the auction price. Sometimes they guarantee prices to sellers, which introduces market risk into their business model. Experts hired by an auction house can tell a great story about a piece of art that attracts other collectors to buy it. They also try (but often fail) to assure the market that a work of art is genuine.

The brief explanation is that traditional art doesn't change hands very often, and with all the mouths to feed to keep the market going, transaction costs are astronomical. While the art market is worth billions of dollars a year, greater transparency and lower fees will create a more dynamic market.

3. NFT: Same but different

The most popular program, NFT, allows anyone to mint digital art works they want to sell. Minting requires a small amount of ETH, which belongs to the project, and additional ETH is needed for network Gas costs. The minting process is the process of creating unique NFT assets that reside on a public blockchain. Ethereum is by far the most popular chain, but Solana and others have been gaining in popularity lately, with some hot projects emerging.

Primary markets don't need galleries or trading platforms to operate. Using social media, projects can create demand and hype for their NFT launch, with users going directly to the project's website to mint coins. Some projects decide to mint through popular NFT marketplaces like OpenSea -- this may or may not be a better strategy, but it's not necessary. The Internet has removed art galleries from their traditional role.

Once collectors have minted an NFT, they are free to sell it on a peer-to-peer basis or immediately list their NFT on OpenSea or other markets (which is what many do). Trying to flip a supposedly rare NFT immediately to make some quick money is not looked down upon. In fact, many collectors boast about how they can quickly turn 0.1ETH into 10 or 100ETH in a matter of hours or days.

For collectors/prospectors looking to grow their collections for more than 24 hours, it's time to tell the community why this particular NFT is valuable. Collectors announce their purchases on various social networking sites, participate in Discord chat rooms, and try to communicate what attributes make a particular NFT "rare." In a medium where art can be copied and pasted for free an infinite number of times, this discussion of rarity is Paramount.

Being able to join an exclusive community of proven owners of a particular project is also a value proposition. Check out the EtherRock community chat rooms on Discord and Telegram, which are limited to 100 holders. Many are proud that they are members of an elite group, but they pay less than the current market price. For example, an EtherRock floor costs around 700 ETH, but less than 50 ETH a month ago.

For explosive projects, the secondary market is very liquid, relative to the physical world. Trading a 1000eth NFT is as easy as listing on a popular platform, or arranging over-the-counter (OTC) transactions via Discord or Telegram. It takes a long time to sell a multimillion-dollar analogue and, as I detailed above, there are high transaction fees. If the network is congested, low-end NFT transactions can cost several hundred dollars in Gas; At the high end, fees are 5% to 10%, depending on the secondary NFT market.

CryptoPunks was the most traded item. In the past two weeks, it traded about 135,000 ETH, or about 500 million US dollars. In art, it is a symbol of great mobility. So you can also blame Christie's for trying to enter the market by auctioning so-called "blue chip "NFT artists, as well as projects like Beeple and Curio Cards.

4. Simple trading strategies

Coins change hands

Market practice is for projects to cast a single NFT at 0.01-0.1ETH levels. If your skill set is scanning social networks and chat rooms for future hot projects, you must quickly cast NFTs.

As a pure speculator, your holding period can be hours or days. But in any case, you are betting that the project can produce a full supply in a short period of time. Shortly thereafter, you'll be listing your NFT collectibles on OpenSea at a multiple of what you paid for them. Then, cheer on your quick action and the high earnings.

As a flip-flopper, you took the nude project Delta. You are trading the floor price of the NFT project. Floor price is the lowest cost NFT price in a series. Depending on the amount of capital you employ, the cost per NFT may not matter. If you hit the next CryptoPunks, Bored Ape Yacht Club, or Pudgy Penguin, your mintage spend could be worth a thousfold in a short time.

Relative value of rarity

A. Tools is an essential tool for any NFT speculator. For hot items, THE Rarity of a particular NFT is ranked by its Rarity. In a series of 10,000 NFTS, how do you know which ones will be more valuable than others? One might be aesthetically pleasing to a large number of people, but it's hard to judge. The objective rarity value can be determined by the different attributes that a particular NFT has or does not have.

Buying at a discount based on NFT rarity is another strategy similar to buying the lowest-priced stocks in a hot industry and playing mean reversion. The best part of the Internet and blockchain is that signals can be found and executed programmatically.

If you do not short hedge the floor price of the NFT project, then you have two types of risk. First, you tested the NFT project in the form of floor pricing. The second is the specific risk of the particular NFT itself. Perhaps for some reason its rarity is not recognized by the wider market, and it fails to achieve mean reversion. If you can short the floor price of a project, do it. In this way, you eliminate project deltas and retain the mean reversion risk you want to take.

Encapsulation and fragmentation

As we all know, popular NFTs can quickly become unattainable. For some holders to drive up prices further, they need populist pricing. If there is confusion, a special purpose vehicle can be set up to insert an asset and then sell the share at a lower nominal price but a larger total to other masses. Encapsulate, and then fragment.

NFT assets can be encapsulated in various smart contracts and then divided into units that the owner can choose. If you have a floor of Ether Rock for 700 ETH, why not create 1000 units of Ether Rock and sell them for 1ETH each? After all, there are more gamblers who can afford NFT at 1 ETH.

This strategy requires savvy traders to take expensive, sought-after NFT and then fragment it and earn a liquidity premium. Fractional.art is the most popular platform that allows you to encapsulate NFT and then split it into smaller units.

Data from Dune Analytics

Not directly, but interesting. PartyDAO developed PartyBid, which allows groups to pool funds to bid collectively on NFT and take partial ownership through Fractional contracts.

From one to more

Due to the power-law nature of social media influencers' followers, using social media to create mental sharing around particular artworks has and will create more accounts that can single-handedly make projects popular. These NFT "tastemakers" do and will publicly display their collections and talk about why a particular project resonates with them or why they believe it will be hot in the future. This creates a positive, reflexive feedback loop that will incentivize NFT gamblers to pay close attention to the blockchain transactions of these collectors.

A simple strategy is to simply buy a floor price NFT for any item held or talked about by a top NFT influencer, which is the power game in the NFT space. The market is still so new and inefficient that adopting this strategy does not require lightning execution skills.

Another longer term strategy is to cultivate your relationships with the above influencers so that you can talk about the NFT that you believe in. If you pick up a specific project that you think influencers will also like, then somehow put it on their radar as soon as they pick up or post anything about the project...... That's going to BOOM.

Here are some studies to watch:

Kenn Bosak is a NFT Twitter influencer who gets a lot of attention with his coverage of various works of art/collections.

NFTLive is a news program focused on NFT, active on YouTube and Twitter. Their coverage provides a lot of exposure for emerging projects/artists.

Beeple has been an influential figure in the field, especially after his sale earlier this year.

Gary Vaynerchuk runs a popular YouTube channel covering the art and technology of NFT. With 3 million subscribers, it is one of the largest YouTube channels focused on NFT.

NFT derivatives

The final frontier will be the most popular item for liquid NFT derivatives. The creativity of financial engineers on the CeFi and DeFi platforms will create new and unheard of ways to speculate and hedge digital art.

An NFT floor price derivative is a logical first step. Traders will want to speculate and hedge on floor prices of hot and liquid items.

CEX floor price derivatives

Derivatives can be easily synthesized on centralised trading platforms -- for example, the CryptoPunk floor price perpetual contract with ETH as collateral. The index price is simply the observed floor price of an item obtained through direct interaction with the CryptoPunk contract. The list price is a measure of the current trading price. Funds are obtained by observing the difference between the list price and the index price.

To synthesize the floor price NFT to hedge short perpetuity positions, the market maker will simply buy any punks that trade at the floor price. Unfortunately, NFT itself cannot be used to provide margin for short perpetuity positions, but I believe it is simple and easy to implement pure synthetic cash settlement perpetuity trades on any CEX. The thorny issues surrounding physical delivery can be handled within the DeFi/DEX domain.

DEX floor price derivatives

Floor price derivatives can be divided into two parts. First, create a protocol that allows users to borrow nETH (ETH supported by NFT) by mortgaging the NFT for a particular project. Users pay a certain interest rate and overpledge the loan. In other words, the floor price of the mortgaged NFT will be greater than that of the borrowed nETH. If the floor price falls, the borrower must make up additional ETH to avoid liquidation.

The second protocol allows a combination of ETH and nETH to be used as collateral to trade a decentralized, sustainable version of the transaction. Add nETH as margin, allowing market makers who short perpetuity contracts to use nETH to fund their positions. Remember that nETH is the NFT of the project and is converted using the observed NFT floor price. Long speculators can leverage long perpetual swaps directly with ETH as margin.

5. Are you a trader or a fool

Don't let the haters distract you, as the emerging NFT market offers plenty of volume and unique trading opportunities. Aside from the fact that you're trading image files, enjoy the ability to trade art the way you trade Stonks.

NFTs is a market that cannot be ignored:

They have a price;

They have numbers;

The market is new but inefficient;

The market is completely electronic;

The market is completely transparent;

Transaction costs are low.

As with any other asset class, there will always be voluntary buyers and sellers of NFT assets. You can sit in Mayfair and trade physical world art while getting hit in the face with fees, or sit at home and wear Lulu's and trade Punks and pay Gas. Same, but different. Again, are you a trader or a fool?