The Future of Derivatives Trading
First released: May 31 2017
Last modified: September 27, 2019 (v 1.01)-
Abstract
EMX proposes to offer a trading platform aimed at revolutionizing global derivatives markets.
EMX is developing the EMX Exchange (EMX), based on this platform, which will offer futures
contracts which give price exposure to underlying assets as varied as crude oil, gold, stock
indices, or bitcoin. Our team consists of experienced quantitative traders, exchange officers,
market makers, FCM employees, and engineers.
We will attempt to dramatically lower the cost of trading and, through the use of a frequent
batch auction model, help ensure an equitable market for our participants.
Liquidity provision is paramount for any new exchange. We have a detailed plan for building
liquidity, notably by creating an internal and external market making program to source liquidity
from exchanges world wide.
The platform will feature a mix of global futures contracts including contracts similar to those
traded on established traditional and crypto derivatives exchanges.
This document is for informational purposes only and does not constitute an offer or solicitation to sell shares or securities or
digital assets of any company, nor does it constitute an offer or solicitation of any commodity interest.
Table of Contents
1. Introduction…..…………………………………………………………………………...………………... 3
2. Derivatives trading fundamentals…………….………………………………………….…………4
a. What is a derivative? What are futures?
b. Who trades futures?
c. How do futures trade?
d. Leverage in the futures markets
3. The current landscape – ripe for innovation……...……………………………….…….... 7
a. Difficult and expensive to access
b. Trading costs are high; fee schedules complex
c. Structural challenges of traditional exchanges
d. The rise of alternate liquidity venues in US equity trading
e. Cost savings from distributed ledger technology
4. Trading on the EMX platform …….….…………………………………………………………. 13
a. EMX Token
b. Futures contracts
c. Trading against margin
d. Clearing and Risk
5. Matching engine…….……………………………………….………………………………………... 15
a. Designing a fairer marketplace
b. The crossing algorithm
c. Benefits of frequent batch auctions
d. Expiration and settlement
6. Illustrating the entire process………….………………………………….……………..….… 19
7. Features...……………………………………………...……..…….................................... 21
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a. Contracts
b. Platforms and Connectivity
c. Language support
d. UI preview
e. Fees and Revenue
8. Sourcing Liquidity…………………………………………………………………………………....24
a. Construction of a dedicated liquidity provision team
b. Heavy stress testing and rules for abnormal conditions
c. Achieving legitimacy
d. Marketing efforts
e. External liquidity provider program
f.
Ability to hedge cryptocurrency risk
9. EMX Token……………………………………………………………………………………………...29
a. Collateral
b. Fee reduction
c. Lending and staking
d. Rewards
e. Voting and Governance
f.
Token distribution
g. Usage of proceeds
10. Legality and Regulatory Oversight ……………..…..………………………………..…..31
a. Legality
b. Regulatory Oversight
11. Disclaimers………………………………………………….………………………….……………...32
a. Value of EMX token
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1.
Introduction
EMX is a platform aimed at reinventing the world’s existing derivatives markets. We aim to
revolutionize the entire trading experience by making it less expensive, easier, and fairer.
We intend to dramatically lower the cost of trading by leveraging cryptocurrency and efficient
design. Our platform will transform the traditional roles of the broker, the exchange, and the
clearing house into a more streamlined process. Building a standardized and modern futures
derivatives market should reduce the cost of managing risk and make the marking, clearing, and
settlement processes more efficient.
Our market design also improves the price discovery process and minimizes market impact
costs. By utilizing frequent batch call auctions in lieu of a central limit order book, we
de-emphasize the importance of speed and reassert competition based on price. The recent rise
of alternative liquidity pools in equities has shown that there is significant demand for fresh
ideas in execution and the sourcing of liquidity; we aim to translate many of these innovations
to the derivatives arena.
Finally, a non-monopolized derivatives market will give unencumbered and democratized
access to a wide variety of futures products. Traders will no longer need to access multiple
exchanges for their commodity derivatives trading, as EMX would list a very broad range of
contracts on a single platform. Price discrimination by other exchanges amongst different types
of market participants would not exist on EMX as traders willall be subject to the same fee
structures and have access to the same data feeds. The efficiencies gained by a
newly-architected platform could also allow for the creation and listing of new futures products,
spurring innovation in the industry and giving market participants new tools for managing risk.
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2.
Derivatives trading fundamentals
2.a. What are derivatives? What are futures?
Derivatives are financial products whose value is derived from the price of an underlying asset –
such as a barrel of oil, a bushel of wheat, a stock index, or a bitcoin.
Futures contracts are a standardized type of derivative that are traded in a centralized
marketplace (an exchange) and cleared by a central counterparty (a clearing house). They are
transactions between a buyer and a seller of a financial instrument at a predetermined price for
delivery or cash settlement at a set time in the future.
For example, if you buy a futures contract for a barrel of oil expiring in December for $50 in
October then you are purchasing the December delivery of 1000 barrels of oil at that set price,
regardless of oil’s price movements from October until then. If the underlying price rises to $60,
the value of the futures contract will rise in value as well, and the holder of the long position in
that futures contract can attempt to trade out of it for a profit before expiry. Of course, futures
contracts can decline in value and there is a risk of loss in every futures contract.
There are other products which fall under the umbrella of a derivative, such as options on
futures or contracts for differences (CFDs). Futures are arguably the simplest and most heavily
traded derivative, as they are well defined and regulated around the world (CFDs are not legal in
the United States unless they are traded subject to regulations as swaps and only between
“eligible contract participants”), so we will focus on futures for now.
2.b. Who trades futures?
Futures contracts are used by a myriad of parties. Their original purpose was for businesses to
create more dependable cash flows and to manage risk by hedging, or protecting, against future
price movements. For example, an oil producer may sell futures contracts to lock in the price of
future revenue so they can have an assured sales price and still meet their operating and
financial obligations (i.e., pay their workers) in the event of a collapse in the price of oil.
Conversely, an airline company may buy futures contracts to lock in jet fuel prices on a forward
basis in order to mitigate a rise in the price of fuel.
Market makers and speculators are also important participants in futures trading. Market
makers will buy and sell with minimal directional inclination, hoping to profit from small
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differences between sell and purchase prices. Speculators, on the other hand, will make bets on
which way the underlying will move, and will carry significant risk in doing so. Market makers
and speculators often assume the risk and provide the liquidity that commercial market
participants and hedgers require.
2.c. How do futures trade?
Futures contracts trade on regulated exchanges, which facilitate the matching of buyers and
sellers, and ensure the integrity of the market. Participants place buy and sell orders at prices
they’d be happy with, called limit orders. A buy limit order for $50 would buy at any price at or
below $50. The collection of resting buy and sell limit orders are collectively referred to as a
central limit order book. Participants are free to wait for incoming orders to match with — called
trading passively —or cross with an existing order — called trading aggressively.
Once a trade is matched, it is intermediated by a clearing house. The clearing house guarantees
the financial performance of what was agreed upon. In financial parlance, the clearing house
takes on the counterparty credit risk of the trade.
In a traditional futures exchange, buyers and sellers interface with the exchange and clearing
house through a broker, an entity which handles the routing of orders and the collateral to back
the trades.
2.d. Leverage in the futures market
The futures market is often characterized by the use of leverage. Leverage, or trading on margin,
means that participants can enter into positions by depositing enough collateral to meet initial
margin r equirements. Initial margin is the amount of collateral, or performance bond, that is
required to deposit with a broker (or clearing house directly) to secure the financial obligations
of the customer.
Purchasing a $1 contract that moves 1% each day will have a 1 cent daily gain or loss, but
purchasing it on 3:1 margin means that you would expect to gain or lose 3 cents on the same $1
purchase instead. Your profit potential is much higher, but so is your risk.
Clearing houses establish minimum initial and maintenance margin requirements that apply to
all market participants. Maintenance margin is the amount of collateral required to remain in a
position. Once a losing trader’s collateral falls below the maintenance margin minimum, the
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broker will issue a margin call to the trader asking for more funding. If the margin call is not
satisfied, the broker can liquidate the position to prevent further losses, as the broker would be
responsible if the trader becomes insolvent.
As a trader stays in a position, a daily mark-to-market m
echanism enforces the exchange of
daily profit-and-loss between the clearing house, each broker, and their customers. This process
works to secure the stability of a clearing house by utilizing standardized settlement prices
established daily by the exchange, so unrealized profit and loss does not build up in the system.
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3.
The current landscape – ripe for innovation
3.a. Difficult and expensive to access
The majority of futures trading volume is concentrated on a few large exchanges around the
world, such as the Chicago Mercantile Exchange Group (CME), the Intercontinental Exchange
(ICE), and the Eurex Exchange. These large entities are the result of dramatic consolidation in
the sector.
CME Group, for example, includes the former Chicago Board of Trade (CBOT), the New York
Mercantile Exchange (NYMEX), the Commodities Exchange (COMEX), and the Kansas City
Board of Trade (KCBT); collectively CME Group trades everything from interest rate futures to
hogs and gold futures contracts. The Economist describes it as “the biggest financial exchange
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you have never heard of” . Intercontinental Exchange was created through the acquisition of the
International Petroleum Exchange (IPE), New York Board of Trade (NYBOT) , Winnipeg
Commodity Exchange (WCE), Climate Exchange Group (CLE), NYSE EuroNext (New York Stock
Exchange), EuroClear & operates 23 regulated exchanges or marketplaces and 6 clearing
houses globally.
These large companies extract massive rent costs from their established markets. In the United
States, futures exchanges are free to dictate where their products are cleared and may also own
or control the clearing house. Market and network effects create a “winner take all” environment
whereby participants have no choice but to migrate to the most liquid market. This often leads
to a single dominant market for each type of futures contract.
Additionally, with only a handful of exceptions, the products for one exchange have no
counterpart in any others. For example, S&P 500 futures are only readily traded on CME, while
cocoa futures reside solely on ICE. Liquidity, licensing agreements and strong network effects
erect high barriers to entry. On a product by product basis, exchanges wield global
monopoly-like power.
This is a strong contrast to equity exchanges, in which liquidity is spread out and competition is
rampant. To trade GM stock, you can source counterparties on NASDAQ, NYSE, or on any
number of private dark pools maintained by banks or market makers. While these liquidity pools
are required (in the United States) to protect investors from accidentally executing at worse
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CME Group: The futures of capitalism,
http://www.economist.com/news/finance-and-economics/--biggest-financial-exchange-you-have-never-heard-futures-capitalism
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prices through the establishment of the National Best Bid & Offer (NBBO) system, they are free
to offer a variety of order types, pricing schemas, --and in the case of the upstart exchange IEX-unique timing mechanisms to differentiate themselves. The equities market has largely
embraced this fragmentation.
Since futures liquidity is so concentrated yet global liquidity pools are distributed across various
exchanges for different contracts around the world, it can be difficult for traders who wish to
trade in multiple contract types to simply trade only on one platform -- and thus it is difficult to
reap the potential benefits of cross-margining across contracts on a global basis. Whether you
operate a multinational business - or simply speculate on global markets - you’ll often need to
source multiple brokers that will route your orders to multiple global exchanges. You’ll need to
trust each with housing your collateral safely, and you often give up the benefits of
cross-margining that can come with keeping multiple positions with one broker.
3.b. Trading costs are high; fee schedules complex
With few exchange operators and strong barriers to entry, it is no surprise that futures
exchanges are extremely profitable. In 2016, the CME had revenues of $3.6B and a net profit
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margin of 43% . ICE enjoyed revenue of $4.5B and a profit margin of 35% during the same year .
The overwhelming majority— eighty-five percent – of the CME’s revenue originated from
transaction and clearing fees, paid by both buyers and sellers on a per contract basis.
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Exchange profits are directly correlated to volumes, and volumes have been growing .
Derivatives volumes in 2016 were the highest they have ever been, led by Asia at 36% of global
volume. Looking at volumes over the last ten years, it is notable that futures volumes are not
correlated to bull / bear periods in the markets; they’ve grown during the recession of 2008 as
well as recent periods of growth. Global appetite for futures contracts has never been stronger.
Futures traders vary, from h
igh frequency trading (HFT) firms who hold positions for seconds, to
physical commodity traders who often use the exchanges for hedging purposes and who have
holding periods of months or years. To maximize profit from these different segments,
exchanges practice extreme price discrimination: participants can pay wildly different fees
depending on their relationship (including membership status) with the exchange or the
volumes that they trade. For trading the S&P 500 E-mini contract, one of the best barometers of
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4
CME Group annual report, 2016, http://investor.cmegroup.com/investor-relations/annuals.cfm
Intercontinental Exchange annual report, 2016, http://ir.theice.com/annual-and-quarterly-reports/annual-reports
MarketVoice, 2016 Annual Volume Survey, http://marketvoicemag.org/?q=content/2016-annual-volume-survey
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the overall American large-cap equity market, exchange fees per contract can range from $0.35
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to $1.18 . The lowest fees are reserved for “member firms”, which require the purchase of high
priced memberships. Volume discounts can lower these fees for member firms or market
makers to $0.10 per contract. HFTs take full advantage of these discounts to make a large
number of low profit trades which other traders simply cannot afford to compete with. This lack
of parity makes it difficult for traders to compete on a level playing field.
In addition to exchange fees, retail clients also pay a myriad of brokerage fees. Two popular
brokers in the United States, Interactive Brokers and TD Ameritrade, charge $0.85 and $2.25,
respectively, to trade the same S&P 500 future. Therefore, the total cost (exchange, brokerage
and clearing fees) for trading one S&P futures contract for a retail trader in the US can be
anywhere from $2.04 or $3.44 using these brokers – many multiples of the $0.10 exchange fee
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(plus brokerage) many HFTs pay .
3.c. Structural challenges of traditional exchanges
The nature of today’s derivatives exchanges creates problems which can’t be overcome by
additional competitors competing on speed or on access.
One problem is inherent to its architecture: since exchanges typically have a matching engine
that processes orders in time-priority, traders are advantaged by being as physically proximate
as possible. This has led to rampant c
o-location, or the practice of installing one’s trading
servers in the same building—or in some cases, even in the same networking equipment—as the
exchange’s matching engine, at significant cost. Trading firms also spend heavily for access to
high-speed communication services, such as microwave lines, to funnel data from one
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matching engine to another as quickly as possible .
Firms employing these strategies recoup their investments by being able to make a large
number of marginally profitable trades with high certainty. For example, when latency-sensitive
traders sense that a large, slow buy order is starting to execute, they will begin buying,
incrementally pushing the price up. By the time the large order is nearing completion, the latency
sensitive firm will be able to liquidate by selling to the large order at a higher price. Since a
co-located firm is able to dart in and out of positions quickly, strategies like this can be very
CME Fee Schedule as of April 17 2017, http://www.cmegroup.com/company/files/cme-fee-schedule-.pdf
This does not include the brokerage fee that HFTs pay. Brokerage fees are privately negotiated and the authors don’t have a way of
determining what they pay
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Time is money when it comes to microwaves, Financial Times, https://www.ft.com/content/2bf37898-b775-11e2-841e-00144feabdc0
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lucrative.
Firms which rely on speed will often have statistical models to predict when they should trade,
but sometimes they have mechanical advantages as well. One publicized example is that the
CME used to disseminate trade information to certain traders faster than it would broadcast it
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to the market as a whole . Since liquidity for its contracts rests solely on the CME, this presents
a huge advantage. In this scenario, if a trader has advance knowledge that the S&P 500 E-Mini is
going to marginally tick up in price, they can send buy orders to purchase any related equity
index on any number of other exchanges, risklessly profiting on the spread.
The notion of trading against a very aware counterparty is known as t oxicity, and the cost of
trading against these agents is known as m
arket impact. Venues which show both sets of buy
and sell orders publicly are known as l it venues, and are notorious as the most toxic places to
trade, for all asset classes.
3.d. The rise of alternate liquidity venues in US equity trading
While futures traders are limited to lit exchanges, US equity markets have evolved into an
entirely different model boasting an abundance of execution destinations. The fragmentation of
liquidity in these venues is organized around the avoidance of toxicity: orders will generally be
funneled into a pipeline which executes the least toxic orders first, and the most toxic orders
last.
The initial destination for many orders is an over-the-counter market. Retail orders, for example,
are matched relatively quickly by wholesale market makers like Citadel or Virtu (ex-Knight
Capital), and often at better prices relative to lit exchanges. Since retail traders are the least
toxic counterparties, market makers will even pay brokers to execute against them in an
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arrangement known as p
ayment-for-order-flow . Non-toxic institutional order flow will typically
be matched over-the-counter as well on specialized dealer platforms.
Unmatched equity orders are next commonly routed to a specific form of off-exchange venue
called a d
ark pool. Dark pools are owned by broker-dealers or market makers and behave very
differently from lit exchanges as posted quotes are not publicly available. From an execution
standpoint, the most important attribute of a dark pool is its ability to control its participants.
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CME Upgrade Soothes Critics Who Viewed Prior System as Unfair, Bloomberg,
https://www.bloomberg.com/news/articles/-/cme-upgrade-soothes-critics-who-viewed-prior-system-as-unfair
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Payment for Order Flow, Bloomberg, https://www.bloomberg.com/quicktake/payment-for-order-flow
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More toxic traders are filtered out, ensuring that remaining orders are relatively benign. Dark
pool traders are consequently more willing to execute large orders since there is less adverse
selection, and market makers can be profitable quoting tighter spreads than they would
otherwise. The net effect for all dark pool trades is that market impact is significantly lower than
if they were executed on lit exchanges.
Off-exchange trading for equities is very popular, and continues to take market share away from
lit exchanges. As of 2016, off-exchange trading in equities was nearly 40% of all volume in the
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United States . Dark pools now account for 15% of total US equities trading . Researchers have
even found that because dark pools concentrate informed traders, price discovery on the public
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exchanges is improved .
Last on the order flow pathway are lit exchanges. Despite differences in fee schedules and
incentive structures, the market impact of trading on lit exchanges is generally much higher than
that of an off-exchange venue.
Dark pools and other off-exchange venues are less common in futures trading. Many futures
contracts on exchanges are thinly traded and can exhibit large price fluctuations when filling
sizable orders. Block trades are permitted, subject to exchange rules and minimum order
thresholds.
3.e. Cost savings from distributed ledger technology
There is significant complexity in the back-office processes which facilitate derivatives
transactions. Payments, clearing, and settlement processes are currently intermediated by a
whole host of systems, depositories, and counterparties which differ across borders and across
products. A standardization of global trade reporting and governance could be a noteworthy
driver of cost savings in simplifying these workflows and increasing overall productivity.
A recent paper from the US Federal Reserve has illustrated this possibility, and even foresees
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larger changes on the horizon:
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TABB Equities LiquidityMetrix June 2017, http://tabbforum.com/liquidity-matrix
Increasing Transparency of Alternative Trading Systems,
https://corpgov.law.harvard.edu/2015/11/24/increasing-transparency-of-alternative-trading-systems/
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Zhu, Haoxiang, Do Dark Pools Harm Price Discovery? (November 16, 2013). Forthcoming, Review of Financial Studies. SSRN:
https://ssrn.com/abstract=-
Mills, David, Kathy Wang, Brendan Malone, Anjana Ravi, Jeff Marquardt, Clinton Chen, Anton Badev, Timothy Brezinski, Linda Fahy, Kimberley
Liao, Vanessa Kargenian, Max Ellithorpe, Wendy Ng, and Maria Baird (2016). “Distributed ledger technology in payments, clearing, and
settlement,” Finance and Economics Discussion Series-. Washington: Board of Governors of the Federal Reserve System,
https://doi.org/-/FEDS-
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[Distributed ledger technology] has the potential to provide new ways to transfer and
record the ownership of digital assets; immutably store information … [potential
use cases] could address operational and financial frictions around existing
services.
Finally, as a recent innovation, [distributed ledger technology] has the potential to also
drive change to the financial market structure in ways that take advantage of the
new technology.
EMX is on the forefront of using distributed ledger technology in streamlining the trading of
derivative contracts.
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4.
Trading on the EMX Exchange
4.a. EMX Token
Our proposed system works through the issuance of the EMX token (EMX), a
n Ethereum-based
token. EMX is used for collateral and discounted fees. EMX holders may also choose to play the
role of a lender and stake their tokens in return for a fee.
The usage of an EMX token as a trader or lender on the platform carries risk, so it is imperative
to understand how the ecosystem works.
4.b. Futures contracts
The EMX exchange will include both traditional and cryptocurrency futures contracts. Futures
on EMX should function largely the same as they do on traditional futures exchanges with a few
exceptions. EMX will administer an auction-based matching model versus a central limit order
book, and contract quantities traded may be fractional, while on traditional trading platforms,
they are whole numbers.
The majority of our contracts will be highly correlated with existing products on liquid
exchanges and EMX may utilize leading benchmarks as part of the settlement process for EMX
settlements.
The mechanics behind order matching and settlement are described in section 5.
4.c. Trading against margin
As explained in 2.d. “Leverage in the futures market”, futures traders need to post initial margin
when entering into a trade. Acceptable forms of collateral on the EMX exchange will be ETH and
EMX initially, with BTC and other cryptocurrencies following in the near future. Different
acceptable forms of collateral may have different haircuts (reduction in available margin).
Traders will have the ability to hedge t heir posted collateral to achieve smaller haircuts (greater
leverage). This hedging is done through shorting an ETH or EMX future for the initial margin
amount. One feature on EMX will give traders will have the ability to a
utomatically hedge their
collateral if they choose, although it will not be required. See section 9 for additional information
on the use case of the EMX token.
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4.d. Clearing and Risk
The clearing house is integral to risk management and exchange functionality. It is there to
guarantee customer performance. EMX will initially operate a centralized clearing house to offer
appropriate safeguards and standards. In the future, our intention would be to introduce smart
contracts on the public Ethereum blockchain where collateral is stored and pre-programmed
(yet, parameterized) risk control decisions are made. Although Ethereum is currently what we
envision as the public chain of choice, we will continue monitoring advancements in blockchain
technology to identify the best technology that will allow for near real-time, on-chain clearing.
The clearing house will also be responsible for maintaining and distributing funds from the
guaranty fund in the unlikely event of a default There will also be additional safeguards to
protect customer funds that will be outlined in the exchange rulebook.
Multiple times per second, EMX will monitor markets and prevent problem positions from
arising. Traders who are in breach of their required margin levels will be asked to deposit more
collateral to EMX. If they do not meet this in a timely manner, they will be force liquidated.
Traders who violate the margin policy and are indeed force liquidated will be assessed an
additional fee which will be used to help fund the insurance fund.
In the extreme and unlikely event there is a shortfall in the system beyond the insurance fund,
unrealized gains may be offset by some losses from delinquent traders, some of which may be
clawed back through legal recourse. EMX is committed to building an institutional grade
exchange and will be implementing measures to inform traders of their current and future
margin requirements to prevent such measures as outlined above.
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5.
Matching engine
5.a. Designing a fairer marketplace
As explained in section 3, slower traders are often disadvantaged when participating in today’s
competitive environment. An attempt in creating a more level playing field must then begin with
redesigning the rules that heighten the importance of speed.
This is not a straightforward problem to solve as trading firms invest large amounts of capital
and manpower on technology optimizations, cutting-edge equipment, and co-locating servers
near exchanges. Any solution needs to make sure that market data both arrives to every listener
near-concurrently, and that every listener has an equal ability to respond.
Introducing a speed bump to outgoing orders, similar to what IEX implements in the equities
market, helps mitigate unfairness when trading across exchanges, but participants can still
receive an advantage by having a closer connection to the IEX matching engine and receiving its
data a little bit sooner.
We’ve decided to take a more drastic measure and forego the traditional central limit order book
completely. We instead utilize a mechanism which we believe is much fairer method of trading,
but one which still facilitates efficient price discovery: frequent batch auctions.
These auctions are designed such that activity is disseminated periodically, rather than
continuously. The recurrent loop of the matching engine – upon which orders are received from
a trader, incorporated into the order book, executed if there’s a cross, and multicasted back to
all listeners – happens on a frequent batch schedule. We envision the batch schedule to occur
every 250 milliseconds. Auction executions will happen at the end of each batch. By
de-emphasizing speed and creating a fairer marketplace, we aim to awaken competition based
on price and execution. Figure 114 below illustrates the flow for our frequent batch auction
process. In our markets, t will be 250 milliseconds, with auction computation times 50-100ms.
We will tune these parameters based on trader feedback.
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Eric Budish, Peter Cramton, John Shim: Implementation Details for Frequent Batch Auctions: Slowing Down Markets to the Blink of an Eye†
American Economic Review: Papers & Proceedings 2014, 104(5): 418–424 http://dx.doi.org/10.1257/aer-
15
Figure 1. Process Flow for Frequent Batch Auctions
With a continuous flow of orders, we also need to decide at what point orders will be rejected
for being too late. Consistent timestamps are of paramount importance in an exchange - and
our backend systems will deliver a consistent timestamp such that traders will always know
whether an order is being considered for the current auction or next. This will also be crucial for
allowing our Exchange Compliance team to ensure market integrity.
5.b. The crossing algorithm
Qualified orders will be matched at a price that maximizes executable volume. This is called the
crossing price. Market orders are matched first followed by limit orders. If there is an imbalance
of buys and sells at the crossing price, unfilled orders from previous auctions are matched first,
and the remaining orders from the current batch are filled pro-rata. Hence, there is no t ime
priority of orders in the same batch. Figure 2 illustrates the crossing price calculation. Note, in
the case where there are no market orders and no limit orders that cross, there will be no trades
(Case 1). When there are market orders or limit orders cross (Case 2), the price that intersects
the most number of buyers and sellers is considered the crossing price and is the price
everyone pays in that auction.
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Figure 2. Supply and Demand Curves and Crossing Price
5.c. Benefits of frequent batch auctions
There have been numerous studies on the efficacy of frequent batch auctions over that of
151617
continuous limit order book trading
i.
. The main arguments in their favor are:
Frequent batch auctions eliminate the speed advantage of the fastest liquidity taking
traders. B
y making liquidity providers less susceptive to order “sniping”, the cost of
liquidity provision would decrease and potentially lead to lower spreads and enhanced
liquidity.
ii.
Auctions are more fair to different types of traders, as everyone pays the same price in
each auction. No longer will the largest or fastest traders get better prices than retail
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Elaine Wah, Dylan Hurd, Michael Wellman; Strategic Market Choice: Frequent Call Markets vs Continuous Double Auctions for Fast and Slow
Traders. http://financelawpolicy.umich.edu/wp-content/uploads/sites/26/2015/10/E.-Wah-Strategic-Market-Choice.pdf
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Eric Budish, Peter Cramton, John Shim; The High-Frequency Trading Arms Race: Frequent Batch Auctions as a Market Design Response . Q J
Econ 2015; 130 (4):-. doi: 10.1093/qje/qjv027
https://academic.oup.com/qje/article/130/4/1547/-/The-High-Frequency-Trading-Arms-Race-Frequent
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Nicholas Economides and Robert A. Schwartz; Electronic Call Market Trading: Let competition increase efficiency. The Journal of Portfolio
Management 1995; 21 (3): 10-18 http://www.stern.nyu.edu/networks/Economides_Schwartz_Electronic_Call_Market_Trading.pdf
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trader or slower institutions.
iii.
Traders pay effectively the mid price, reducing the transaction cost to enter a trade.
The bid/ask spread goes away in auctions, and a buyer and seller within an auction can
transact at better prices for both.
iv. Regulators and market observers can better survey markets. By reducing the number of
tradable time points, data will be simpler to visualize. With fewer speed-sensitive traders,
liquidity providers will also cancel orders less frequently, decreasing the size of market
data feeds. All participants on the exchange will be anonymous, and all traders will have
a unique identifier and time stamp associated with their account.
v.
Data dissemination will be fairer. T
he EMX reporting of the marketplace would occur on
a strict schedule a few times every second. This means traders don’t have an incentive
to race to save a few milliseconds from their orders, resulting in a more fair marketplace
where people compete on price, not speed.
5.d. Expiration and settlement
Settlement and expiration procedures for each futures contract on the EMX platform will be
specified in the Exchange rulebook. For proprietary contracts traded only on EMX, we will create
our own settlement procedures. For contracts that are also listed on other Exchanges, we will
likely settle to the prevailing most liquid price.
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6.
Illustrating the entire process
For further clarification, let’s walk through the entire process with a graphical aid.
1. The trader deposits collateral with the EMX clearing house.
2. The trader sends an order to the exchange. It passes through a pre-trade risk check.
3. If the risk checks pass, the order is sent to the matching engine.
4. Before adding the order to the order book, the exchange matching engine ensures that
the order has adequate margin by inquiring with the clearing house.
5. If the order is included in the cross of the auction, an execution occurs and the trade is
settled at the clearing house. Orders not executed remain on the orderbook until
canceled.
6. After contract expiry or closing a position, gains/losses and collateral are automatically
returned to the trader.
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7.
Features
7.a. Contracts
EMX will list both crypto futures and traditional equity, commodity, and currency futures. Some
of the initial contracts will include:
●
BTC-USD
●
ETH-USD
●
EMX-USD
●
EMX Large Cap Crypto Index
●
US Equity Index
●
Oil
Our system was built with scalability in mind and we will add additional contracts over time
(crypto, equities, commodities, currencies, bonds, etc), in collaboration with our community and
dictated by what traders around the world desire to trade.
7.b. Platforms and Connectivity
We will launch a web-based trading platform with R
EST and WebSocket APIs. Additional
enhancements will include:
●
Mobile “responsive” web App
●
Native Android App
●
Native iOS App
●
Native Desktop Apps (Windows, OS X)
●
FIX APIs
7.c. Language support
We will launch with English, Korean, and Chinese language options in the trading application.
Other languages (Japanese, Russian, etc) will be implemented over time.
7.d. UI preview
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Web
Mobile
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7.e. Fees and Revenue
Sources of revenue for EMX include:
Exchange fee
Trading fees on a notional basis, instead of per contract basis
Withdrawal fee
EMX may charge a small withdrawal fee
Liquidation fee
Traders who are force liquidated due to insufficient margin will be
charged a liquidation fee, which will be used to fund the guarantee
fund
Other fees
New features of the EMX platform may charge fees (for example,
lending).
See section 9 about reducing fees using the EMX token.
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8.
Sourcing liquidity
The biggest hurdle in establishing a new futures platform is liquidity. When contracts are illiquid,
price discovery is more difficult, impact costs are higher, and the market is less attractive to all
parties.
Over the past year, we have spent a significant amount of time talking with prominent futures
traders, exploring the weaknesses of existing platforms, and assembling a team with the
technology and financial know-how capable of building an attractive alternative to today’s
exchanges. We believe we understand the challenges associated with generating liquidity on
our platform.
We highlight a few of our key strategies for this below.
8.a. Construction of a dedicated liquidity provision team
We aim to build a committed l iquidity provision team for futures contracts on our platform. Its
aim will be to maximize crossed volumes (i.e. minimize auction imbalances) instead of profits
and can be thought of as a l iquidity provider of last resort: if there is an imbalance of buyers and
sellers, the internal liquidity provision team will step in and fill the traders who did not get filled.
This team will operate and trade with the same market data, capabilities, and limitations of any
other trader. In other words, it will operate entirely separate from the Exchange and will not be
privy to any information that isn’t publicly disclosed.
As liquidity provisioning inherently takes on positions which are less popular, this effort may
take some time to get going. While research and production code for this entity will not be made
public, monthly profit and volume performance will be displayed when possible.
A dedicated volume-first “market making” strategy like this is common in many large equity
agency dark pools. These volume-oriented teams work to backstop many different metrics of
execution quality, such as price improvement or fill percentage.
8.b. Heavy stress testing and rules for abnormal conditions
One of the keys to cultivating liquidity is having a system which is reliable during high volume
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and high volatility periods.
Financial markets are characterized by extreme “bursty-ness”. Though the majority of time is
spent in relatively calm waters, the minority of volatile periods is several magnitudes higher in
every metric—volume, variance, skew, etc. This is true at every time horizon, whether you are
looking at markets on a minute-by-minute basis, or on a day-to-day scale.
Additionally, plotting the returns of any time horizon on a frequency basis (such as on a
histogram), will show that markets have very long left-handed tails—also called negative skew.
In other words, when markets rise, they tend to rise slowly over time; when they fall, they fall
violently and quickly.
What this all means is that our system needs to be able to operate well during tail events. While
many individual traders may switch to our platform because of the appeal of lower transaction
fees alone, established players will know that fortunes are made or lost during times of extreme
market dislocation.
We intend to attack this problem with a multi-pronged approach:
i.
Regular stress tests. We will simulate the order profiles of volatile periods in the past
and measure our system throughput and performance during those times.
ii.
Maximum price movements. Contracts will have built-in stop conditions similar to that of
existing exchanges, which impose maximum limitations on price fluctuations against
some reference price.
8.c. Achieving legitimacy
An important part of this endeavor is establishing a legal method of trading futures on a
blockchain. As we expound upon in Section 10, our intention is to create a regulated, legal
approach for all parties on the platform -- our company, EMX holders, and traders.
Regulators are an important part of building public trust and safeguarding markets, and we
intend on building strong relationships with them. We believe that bringing down cost and
complexity barriers can be done without sacrificing market stability, and that our proposed
platform will not just “do no harm” but will improve and innovate. In fact, judging by recent
statements, we believe we see eye-to-eye with regulators like the CFTC in a shared mission of
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fostering “open, transparent, competitive, and financially sound” markets .
8.d. Marketing efforts
Developing an extensive global community of traders is essential for EMX to succeed and have
liquid markets. EMX plans to generate wide interest for the exchange, build and retain a large
user base, and foster advocacy for the product, through a variety of marketing campaigns and
activities. In the cluttered crypto ecosystem, we cannot simply rely on organic word-of-mouth
growth or traditional tactics. Our marketing will be executed and amplified through a generous
referral program, multiple trading competitions, paid advertising campaigns, influencer
marketing, community outreach and event sponsorships, and strategic marketing partnerships
with trusted brands. Highlights include:
Referral Program
Prior to our token sale, we will implement a referral program that rewards users for completing
simple actions, such as creating an account on EMX.com, following our social profiles, and
referring other users to the platform. When the exchange launches, this referral program will be
modified to become a commission-based affiliate program, where traders will earn reduced
trading fees or a number of trading credits for referring their friends.
Trading Competitions
We will host recurring trading competitions to create brand awareness and generate PR buzz.
By offering appealing prizes, we will incentivize users to try a simulated version of our platform
and challenge them to one-up each other. These competitions will be amplified on social
channels and traders will also be rewarded for referring others to compete. This will build a
large email list and subscriber base that we can later use for marketing and conversions.
Community Outreach
We will leverage ambassadors in key markets to plan and organize meetups that will organically
grow the EMX community. The EMX team will also attend and sponsor 10-15 international
conferences such as Consensus Singapore, the World Blockchain Summit, BlockShow Asia,
Korea Blockchain Week, Berlin Blockchain Week, Devcon, and more, to spread awareness of the
exchange.
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CFTC Mission Statement, http://www.cftc.gov/About/MissionResponsibilities/index.htm
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8.e. External liquidity provider program
We also keep a large percentage of our tokens in reserve for the purpose of fostering our
external liquidity provider program. This is a program to incentivize external liquidity providers to
quote on our platform, and will be done in conjunction with our sales and marketing efforts.
The liquidity provider program will loan reserve tokens to select and qualified providers with the
requirement that these tokens are used to fulfill late-stage auction imbalances. Our hope is that
this program will encourage liquidity providers to trade during the platform’s early days while
minimizing their risk and initial cash outlay.
8.f. Ability to hedge cryptocurrency risk
One common reservation for many potential traders we’ve spoken with is that crypto-currencies
can be too volatile to hold. Given the price variance of BTC and ETH in recent years, it is very
possible that any potential futures trade priced in a crypto-token, particularly one with a
longer-term and directional focus, will be dominated by the token’s price change rather than
anything else.
To address this, we have allowed for traders to hedge their initial margin, effectively fixing the
price of their crypto collateral to USD. While this is optional, the added benefit of hedging will be
a reduction in haircuts applied to hedged collateral (allowing increased leverage).
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9.
EMX Token
As mentioned in section 4, the EMX token is intended to be used to access the liquidity on the
EMX platform. Market makers use EMX as collateral alongside other forms of cryptocurrency
collateral. In addition, EMX may be used to reduce fees.
9.a. Collateral
Market makers on EMX may use the EMX token as collateral.
9.b. Fee Reduction
EMX will charge trading fees listed in section 7.e. Those holding EMX can receive fee discounts.
9.c. Lending and Staking
EMX holders can lend and stake their token with EMX can earn fees from growth in the
insurance fund. Every two weeks, 10% of net gains in the insurance fund will be paid out to
holders who have kept their tokens with EMX. Payment is pro-rata and based on how long
tokens were staked in that period. In the unlikely event there are net losses to the insurance
fund, tokens from the staked fund will be used to make traders whole, and stakers may receive
less than they deposited.
9.d. Rewards
Customers who hold enough EMX can unlock premium features on the exchange,
including higher leverage, and will earn more prizes if they participate in EMX-hosted
trading competitions.
9.e. Voting and Governance
EMX holders can vote on new features and products, and help prioritize the EMX
roadmap.
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9.f. Token distribution
The goal of any exchange is to have ample liquidity and trading volume. After all, what good is a
market if nobody shows up to buy and sell goods? Therefore, we have a large pool of tokens
reserved for market makers (50%), which will be used to jumpstart the virtuous liquidity cycle, as
liquidity attracts more liquidity. Market making tokens are used by the internal liquidity
provisions team and external market makers as collateral to trade and supporting the growth of
the exchange by possibly converting to USD to take the long side of EMX-USD futures positions
or as collateral on traditional exchanges. Tokens used outside of these needs, if any, can only
be used on a monthly vesting schedule over 4 years, with a 1 year cliff. Tokens for founders also
have 4 year vest with a 1 year cliff.
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9.g. Usage of proceeds
The majority of the funds in the first phase are intended for development, with the rest split for a
dedicated sales and marketing staff to bring traders onto EMX, legal, and operations. In
addition, we have reserved part of the initial proceeds for the internal market making team to
ensure there is liquidity on our exchange. During the second phase, we intend to utilize the
proceeds from to further capitalize the market making team, to support liquidity operations in
more contracts and in a larger capacity.
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10.
Legality and Regulatory Oversight
10.a. Legality
The legal issues involved in an endeavor of this nature are complex and uncertain. Our team is
working diligently with experienced legal professionals to ensure that our platform is within
complete compliance of all applicable requirements where we operate. We have no desire to
conduct or condone unlawful activities, nor subject token purchasers or holders to prosecution.
10.b. Regulatory Oversight
Cryptocurrencies are in their infancy and many global regulators have differing opinions on how
to treat and oversee cryptocurrency exchanges. Some jurisdictions have created clear rules,
others have given guidance and yet another subset have remained silent. EMX’s goal is to
create an institutional grade exchange that operates offers our traders the highest level of
transparency and protection. In order to do so EMX has a two prong approach.
Initially, the Exchange will be domiciled in Bulgaria. We intend to operate our Exchange in global
jurisdictions that permit trading of self regulated crypto to crypto derivatives contracts. We will
perform AML/KYC on our market participants and prohibit traders from certain jurisdictions
where it is not permissible for them to access our markets. We also intend to publish an
Exchange Rulebook and will have a compliance and market regulatory function that will perform
market oversight and enforcement. Further details will be contained in our Terms of Service
upon signing up for EMX and the Exchange Rulebook which will reside on our homepage.
Our ultimate goal is to be regulated under the US Commodity Futures and Trading Commission
(CFTC). As part of that process, EMX intends on filing with the CFTC to become a Designated
Contract Market (DCM) and a Designated Clearing Organization (DCO). These two designations,
if granted, will provide us the authority to operate an exchange and clearing house under one of
the most respected regulatory bodies in the world. There is no guarantee that we will be able to
obtain such designations from the CFTC. The Platform is not intended to be available in the U.S.
or to U.S. Persons absent proper approvals.
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11.
Disclaimers
This document is intended to introduce EMX to the world, and is for informational purposes
only. This document does not constitute an offer or a solicitation to sell shares or securities in
any company. It is not a prospectus for investment.
This document has not been written towards the laws or regulations of any particular
jurisdiction. While this document -- specifically Section 10-- may have references to or
interpretations of laws in the United States, these references and interpretations are not legal
advice and should not be used to make any legal or financial decisions. The general public
should conduct their own “due diligence” regarding any statements or conclusions made,
explicitly or implied.
This document does not constitute a promise of any kind. This project is constantly evolving
and any information in this document is subject to change. Our project is an ambitious one, and
though we believe that we are uniquely suited for the challenge, we cannot offer an assurance
or a guarantee of success in any fashion.
This document contains forward-looking statements. These forward-looking statements, which
you can identify by our use of words such as “expects,” “plans,” “estimates,” “anticipates,”
“projects,” “intends,” “believes,” “outlook” and similar expressions that do not relate to historical
matters, are based on our expectations, forecasts, projections, and assumptions at the time of
this document, which may not be realized and involve risks and uncertainties that cannot be
predicted accurately or that might not be anticipated. These could cause actual results to differ
materially from those expressed or implied by the forward-looking statements.
11.a. Value of EMX token
The EMX token is a tool intended to be used for trading on the EMX platform. The usage of the
EMX tokens carries risk. The EMX token should not be expected to gain value or have value
outside of these roles. A token is only used at the behest of the token owner, and any time it is
used, there is a possibility that the token will lose value or be lost.
The EMX token is not an investment in any way, shape, or form. Possessing the token does not
grant the owner a share of any profits outside of any made through his own endeavors in the
stated roles above. Passively holding the token has no expectation of profit or value.
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The EMX token is not intended to be a security. Possessing the EMX token does not grant the
owner any ownership, right, or interest in any company, enterprise, or undertaking.
If exchanged for or compared against any other asset, the value of the EMX token may be
volatile. EMX makes no assurances regarding the value of an EMX token, and any fluctuations in
its value are outside of our control.
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