A Polychain-backed derivatives exchange is launching soon, exotic swaps for bitcoin’s hashrate and mining difficulty in pipeline

A new crypto derivatives exchange known as Alpha5 is planning to launch in the next two months.

Backed by Polychain Capital, Alpha5 plans to offer bitcoin futures and options, as well as exotic or customized derivative products. It wants to "do for exotics what BitMEX did for futures," according to a pitch deck seen by The Block.

Alpha5 founder Vishal Shah confirmed the validity of the pitch deck and said that the exchange plans to launch several products. To start with, Alpha5 would launch a "perpetual swap with amplified funding, futures and the futures swaps" in early summer of 2020 and options products towards the end of the summer, Shah told The Block.

"Alpha5’s cornerstone product will be Futures Swaps. Some traders also refer to these as Futures Spreads and Calendar Spreads. These are quite standard products in legacy markets, and act as the scaffolding, upon which more convex products are built. However, they are absent in the crypto-sphere," he said. 

Shah added that a credit-default future is also expected to launch in Q4 and a hashrate future "is on the whiteboard and should have live implementation by mid-2021" and bitcoin difficulty swaps could follow next.

"We're working on a design to help free-float a hashrate future well beyond the expected two-week predictability horizon of bitcoin hash," said Shah.

Hashrate futures are derivative contracts that allow bitcoin miners to hedge the hashrate or the bitcoin network's processing power. Bitcoin's hashrate keeps fluctuating, which could impact  production cost and eventual profits for miners.

Difficulty swaps, on the other hand, help bitcoin miners to mitigate the risk of increased mining difficulty, which could reduce their expected coin production.

Exotics 

While exotic products work well in theory, there are some issues such as liquidity, market participants told The Block. 

"Any new products need consistent and predictable liquidity to kickstart activity, and whether there are enough market makers in the space currently that are willing to quote two-way prices in exotic products is not clear to me yet," said Tiantian Kullander, co-founder of crypto market making and trading firm Amber Group.

Darius Sit, managing partner at crypto derivatives trading firm QCP Capital, echoed Kullander's views, telling The Block that liquidity remains a key issue for newer products. "There are numerous derivatives exchanges offering very similar products. But liquidity remains quite centralized in the top few."

Emmanuel Goh, co-founder and CEO of crypto derivatives data platform Skew, also told The Block that "the main challenge for liquidity providers is hedging and for the issuer is its balance sheet capacity to deliver the payoff."

But Alpha5's Shah seems less concerned about liquidity issues. "I'd say our biggest edge is Implied Orderbooks. This is something you see onshore (i.e. CME), and no major crypto exchange offers this. It's needed to help intertwine liquidity between an exchange's products, and also introduce new products without needing to necessarily tap new liquidity," he told The Block. 

Some other market participants think that demand for exotic products would grow. "Many miners have approached us proactively to explore how they can better hedge their risk. With the recent volatility, miners are more conscious of their overall risk strategy entering the halving," Rich Rosenblum, co-founder of crypto derivatives trading firm GSR, told The Block.

A few little-known crypto firms already provide such derivative products for miners, including Interhash (a partnership between Canaan Creative and GSR), Delta Exchange and crypto brokerage BitOoda.

"As mining operations continue to grow in scale and sophistication, the need for bespoke risk management strategies grows exponentially. The Hashpower Contract and Difficulty Swap developed by BitOoda gives miners additional tools to customize the risk/return profile of their facility, while also giving financial buyers products to generate alpha and overlay trading strategies," Timothy Kelly, founder and CEO of BitOoda, told The Block. 

Alpha5 launch 

Alpha5 is currently undergoing audits in a test environment and is expected to launch in June, Shah told The Block. 

When launches, the exchange would target the Asian market for business, said Shah, adding that Alpha5 would be based in India – either Mumbai or the National Capital Region.

There are currently six people working for Alpha5 and the firm is looking to hire more people for its operational and business development efforts, said Shah.

Alpha5 is backed by Polychain Capital, but Shah declined to disclose the sum invested by the venture firm. 

Shah further told The Block that Polychain is Alpha5's sole investor for now. "This was a very non-standard investment for them [Polychain], but the leadership there carries high conviction in Alpha5, and we have been working hand-in-hand to bring that to fruition," said Shah.

When asked if the firm is looking to raise more funds in the near future, Shah said: "We've been lean and extremely resource-efficient to date; we really don't want to take on more capital than we need."

Polychain Capital portfolio manager Sherwin Dowlat confirmed backing Alpha5, but declined to disclose the sum invested.

"We are very excited by Alpha5's products, including the first insurance fund-related token ever, and believe they add a new dimension to trading by taking fragmented liquidity across different products and concentrating them into fungible products that are robust but more intuitive to trade across futures, options, credit, and exotics," Dowlat told The Block.

"These products will open new trading opportunities and promote flow with existing structures. Alpha5 will sit at the core of what we anticipate to be the biggest area for growth in cryptocurrency trading – derivatives," he added.

Tokenized insurance fund 

Alpha5 plans to launch a token called "A5T," which will represent a tokenized claim on a proportion of its insurance fund.

"I wanted to give holders of A5T something more concrete than an esoteric proxy to equity. Therefore, the insurance fund was removed from the equity umbrella of Alpha5, and tokenized for the benefit of A5T holders," Shah told The Block.

"We are also not doing any public sale. Most A5T will have to be earned by 'takers' on the exchange. In any instance, insurance fund = NAV for the totality of A5T holdings, which is a comforting fact in bear markets, and a back-stop in bull markets. We have not seen this model implemented anywhere else," Shah added.

Staking is also expected to be rolled out for A5T holders, which will enable a reduction in trading fees, Shah told The Block.

Room for growth? 

While it remains to be seen how Alpha5 would perform, the overall derivatives market is poised for growth, GSR's Rosenblum told The Block.

"There is still plenty of demand to expand the derivative market within crypto, even without further growth of the asset class – which is unlikely. In 2019, global GDP was $90 trillion, and the derivative market was $900 trillion," said Rosenblum. 

QCP Capital's Sit said it remains to be seen what kind of traction Alpha5 will get. "Don't think it's anything new. They are just making it slightly easier to execute strategies such as spreads which most players are able to execute quite easily already," Sit told The Block.

Alpha5's Shah said: “No major crypto exchange offers implied orders. It’s easy for any sophisticated trader to appreciate the material benefit this creates for liquidity. Existing options for executing spreads are highly rudimentary. "

Update (April 18): This story and its headline have been updated for clarity