Ben Zhou is trying to create a new’n’improved exchange venue for currencies in the crypto world. It involves creating a platform that is built for speed – with risk management the tradeoff.
Bybit, the derivatives exchange he co-founded in 2018, has just notched a record trading day and surpassed BitMEX and OKEx to become the third-biggest venue for crypto derivatives.
The firm, domiciled in the British Virgin Islands, is riding the current boom in cryptocurrency. Zhou says Bybit’s success so far is not just market trends but the way the team has constructed its operations.
Winning market share
On Monday, February 22, Bybit hit $28 billion of daily turnover, a record for the business. On Tuesday, according to Coinmarketcap, it turned over $34.5 billion – plenty more than OKEx ($18.4 billion), BitMEX or another rising star, FTX.
In the crypto derivatives space, Bybit still has a ways to go before it can challenge the duopoly on top, with both Huobi Global ($85 billion) and Binance Futures ($83 billion) duking it out.
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Unlike the two leaders, though, Bybit’s success is based on a concentrated book of business. The venue operates only 10 contracts, mostly pairs against Bitcoin. The biggest players are more like coin supermarkets, with Huobi operating 914 contracts and Binance 1,063.
“Binance wants to be the entire crypto ecosystem,” Zhou said. “Bybit is built to focus on our products.”
That means limiting its scope of activity, at least for now. Bybit does not offer spot trading today, and its 10 contracts are all of one type, the perpetual contract.
Its fee structure may also help with winning liquidity: it pays market makers 2.5 basis points, or .025 percent, for flow, versus the 2bps paid by its competitors (BitMEX also pays 2.5bps).
But Zhou attributes the venue’s success to the underlying structure. He worked for nearly eight years in Shanghai at XM, a retail broker specializing in foreign exchange and contracts for difference (CFDs).
A CFD is a risky, highly leveraged swap that trades on margin. With CFDs, a buyer pays a seller the difference between the current value of an asset and its value at contract time – it’s a spread bet. CFDs come with considerable counterparty risk, if they trade without the benefit of a clearing house.
This familiarity with forex, risk and leverage attracted Zhou to co-found Bybit in the mold of a currency exchange but built for the 24/7 world of crypto.
This is partly a technical challenge, to ensure the exchange does not face outages and can handle volumes 24/7, any day. Zhou says today Bybit typically processes about 10,000 trades per second, but its matching engine could handle about five times more throughput.
Speed versus risk
This leads to the second challenge, which is how Bybit structures its processes, adopting a forex broking model to crypto. A traditional forex trading platform has a linear process: a trader must first tick the box for risk management and for margin before a transaction goes to the matching engine.
“This is the prudential approach,” Zhou said. “We conduct these processes in parallel.” This means different risk and margin requirements may get ticked among many venue participants while trades also enter the matching engine. The idea is to speed up transactions and therefore boost liquidity. Zhou attributes Bybit’s faster process to its surpassing BitMEX’s volumes.
However, this means Bybit does not conduct cross margining.
Cross margining involves taking one trader’s excess margin to another’s so that traders can maximize their capital efficiency and minimize their net settlements. This function is usually supplied by a clearing house or a prime broker. Because it reduces the likelihood of having to liquidate positions at losses, cross margining is considered vital to managing risks through volatility.
Zhou says the firm initially offered cross margining, but it was difficult to maintain given the need to facilitate trades at speed. He says the company may reintroduce it, “But right now our model is successful.”
Bybit is looking to add new contract types, including expiration contracts, in which the owner of a contract can exercise the option, close the position, or let the contract expire (worthless). This is the most common type of contract in the traditional world of futures and options, but in crypto, the perpetual contract (with no expiry date) has been the dominant structure (pioneered by BitMEX).
Bybit is pure crypto, trading only crypto pairs. To admit fiat-crypto pairs or to expand into crypto-commodity pairs would require a license. This is a long-term possibility but Zhou says intermediate steps are more likely, most likely stablecoins. Bybit could also enter the spot market, so its uers can better hedge their positions, although Zhou wants to make sure the business stays focused on winning the derivatives market.
DigFin asked for his take on Tether, aka USTD, allegedly a stablecoin pegged to the dollar whose backers notoriously refuse to say whether they actually hold the dollars to match the Tether coins they are minting at a furious pace.
“Tether is dangerous,” Zhou acknowledges. “It poses a systemic risk. But it’s so popular, and so widely accepted, that the consensus is holding up its value. It’s become a major tool for margin trading.”
Bybit will consider introducing swaps into alternative stablecoins, such as USDC (another dollar-pegged coin that is more transparent in its reserves management) or synthetic collateral tools such as DAI and MakerDAO. These would make for valuable sources of collateral for traders trusting them as margin.
Zhou predicts the crypto market will grow “100 times” over the next 20 to 30 years. “Our job is to provide a derivatives market that works. We may diversify our offering but it has to stay in our product mission.”