In the latest “Crypto Trader Digest” from Arthur Hayes, CEO of BitMEX, a cryptocurrency derivatives exchange, he has produced an easy to read well-crafted “Segwit Decision Tree” which timelines events related to Bitcoin’s User Activated Soft Fork (UASF). He starts from July 14th continuously through August 1st with possible scenarios and outcomes based on different determinations.
After graduating with a degree in economics from the Wharton School of Business, Arthur lived in Hong Kong as an equity derivatives trader. He was the market-maker for Deutsche Bank and Citibank’s Exchange Traded Funds (ETF) businesses. He also has extensive experience trading equity index futures, forwards, and swaps as well as non-deliverable FX forwards. Arthur brings a deep understanding of how to structure and trade financial derivatives.
The full article is below:
Segwit Decision Tree
Catharsis is nigh. The User Activated Soft Fork (UASF) flag day is 1 August 2017. Should Segwit (BIP141) not be activated by the flag day, the implementations of Bitcoin could multiply. This has serious implications for traders of Bitcoin and any other digital currency.
Segwit + a hardfork to a larger block size at a future date, known as “Segwit2x”, is a face-saving compromise put forward by large miners. Some worry that this technology cannot be safely tested and implemented by August 1st. However, if successful, the activation of Segwit2x will keep Bitcoin intact for now.
Segwit2x requires 80% of the network hashrate to signal during a 336 block period. That is roughly 2 ⅓ days. Practically speaking, Segwit2x must be locked-in by July 29th in order to make the August 1st deadline.
Many people smarter than me have opined on the issues surrounding the Bitcoin scaling debate. As such, I will only focus on the relevant dates traders should etch into their memory.
On this date, miners, wallets, and other nodes can download the BTC1 software, Segwit2x, and begin testing. BTC1 was released on June 30th so there shouldn’t be any surprises when official testing by the signatories to the NY agreement actually begins.
The market will react positively or negatively depending on the type of comments emanating from large and vocal miners regarding the state of the Segwit2x technology. Expect volatility to rise dramatically after this date and until August 1st.
Playing the XBTU17 basis will allow traders a market neutral way to capture this volatility. If you don’t know what I’m talking about, I suggest watching my latest seminar.
Miners can begin signaling for Segwit2x. If it appears that the 80% threshold will easily be achieved, expect the market to scream higher. The relief rally will be intense as everyone breathes a sigh of relief that a UASF-induced chain split will not occur.
If the % of hashrate signaling for Segwit2x is very low, and it appears that it will not reach 80% over the next week, expect dump city. It is still entirely unclear how many of the largest spot exchanges will deal with multiple implementations of Bitcoin. As a result, traders will sell Bitcoin and wait for the dust to settle.
Those who wish to remain exposed to digital currencies may increase their holders of the large-cap altcoins. Big Daddy Vitalik’s Ether will experience inflows of biblical proportions. The best feature of Ether is that decisions can be heavily influenced by the boy-God Vitalik. Traders always favor certainty over chaos; even if that chaos could birth a better Bitcoin.
If the % of hashrate signaling is neither too hot nor too cold, the market will slump, but traders will hold out hope for a successful activation.
This is the deadline for Segwit2x to be locked in in advance of UASF flag-day. After Segwit2x is locked in, miners have another 336 blocks before activation. Segwit2x must be activated on or before August 1st. Failure will result in Armageddon.
The final hope, then, is that Segwit (BIP141) is locked-in by July 31st. But that would require a two-week difficulty adjustment period ending on or before July 31st. It is unknown whether that will occur.
If spot exchanges clearly communicate how a chain split and or hard fork of Bitcoin will be handled, traders may not dump their stash en mass. However, another problem presents itself.
The general public, who now for the first time dipped their toes into the piranha-infested digital currency waters, will wonder what this all means. They have no idea what a chain split, a hard fork, or a BIP is. They just want to participate in the next get-rich-quick internet scheme.
As the price plummets they will wonder what is going on. When the mainstream financial press explains the precarious position Bitcoin is in, they will delay future purchases and sell their holdings.
There may be opportunities to go long Bitcoin at depressed levels a few days prior to July 29th in hopes of a Christmas miracle. Otherwise, if you are still long by this day, you could be staring at some ‘yuge’ red numbers on your computer screen.
Assuming Segwit2x failed, the antichrist is upon us. There is a possibility of four different implementations of Bitcoin. Read Bitcoin Magazine’s excellent summary of what may happen, essentially:
UASF Flops (BIP148)
If this happens, the price of Bitcoin should have already started dumping on July 29th. Now, the upside risk for shorts is that the amount of hashrate supporting the UASF is minuscule. At that point, exchanges would not bother supporting BIP148 Bitcoin as it has no oomph behind it.
This presents miners supporting big blocks an excellent opportunity to hard fork onto larger blocks. Jihan Wu, Bitmain CEO, already opined that he will hard fork regardless of whether UASF succeeds or fails. It is not guaranteed that a hard fork could happen without issues, but this is the best time from their perspective to attempt one. Should it succeed, Bitcoin will quickly erase all prior losses and surpass $3,000.
UASF Muddles Through
In this scenario, BIP148 Bitcoin has less than 51% of the network hashrate, but enough that it is dangerous. This is the worst outcome by far. Jihan will still hard fork, and in retaliation, Bitcoin core might alter the Proof of Work algorithm to render all ASIC miners useless on a new version of BIP148 Bitcoin.
Now we have 4 versions of Bitcoin. BIP148 Bitcoin, new POW BIP148 Bitcoin, Legacy Bitcoin, Hard Forked Bitcoin. Oy vey. It is impossible to predict which one gains enough hashrate to survive. Noobs will not know which “Bitcoin shitcoin” they should purchase. Hopefully, that doesn’t deter them out of investing in the industry completely. They might purchase Ether or another digital currency instead.
Exchanges will support 1 or more of Bitcoin versions in the wild. This will not be an Ether vs. Ether Classic like situation. That hard fork occurred when the combined market cap was less than $1 billion. The toxic ideological differences underpinning the Bitcoin scaling debate dwarf the consternation caused by the failed DAO. Each camp is ready to lose significant amounts of money in their quest to advance the “true” version of Bitcoin, sounds like organized religion.
Hence, the sum of the parts will not equal or exceed the prior value of Bitcoin. If you still hold physical Bitcoin at this point, it is pointless to sell it. Rather, it is time to bet the house on which version you believe will survive. Those who bought or held ETC since the 2016 hard fork are jumping for joy, for example.
UASF Succeeds Instantly
If BIP148 Bitcoin garners >51% of the network hashrate, UASF supporters are victorious. Exchanges have no incentives to support legacy Bitcoin. Jihan might also call off the dogs, and refrain from hard forking.
BIP148 Bitcoin is in fact Bitcoin once more. All hail Segwit. Of the lows, which surely will be below $2,000 or maybe even $1,000, the price will easily take out $3,000 and quickly head for $5,000.
Many miners will still believe Segwit to be an inferior (i.e. it makes them less money) way to scale Bitcoin. However, they can’t argue with a high and rising price. The discord between Bitcoin Core and miners who desire bigger blocks will continue to simmer but will not boil over into another cathartic event like UASF for now.
Me Like Volatility
If Cookie Monster fed on volatility instead of sugary bread crumbs, he would be excited about the upcoming events. While realized 30 days annualized Bitcoin volatility is quite high at 90% (.BVOL Index), it will seem like a calm kiddie pool compared to the stripper-like gyrations to be experienced if Segwit2x fails. No sex in the Champagne Room.
Traders not present in 2013 and 2014 will discover why Bitcoin is the most volatile asset in human history.
Risk Disclaimer: BitMEX is not a licensed financial advisor. The information presented in this newsletter is an opinion and is not purported to be fact. Bitcoin is a volatile instrument and can move quickly in any direction. BitMEX is not responsible for any trading loss incurred by following this advice.