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Comment by bogomipz | Hacker News Reader

>"The decision to clear client trades will be made on a case-by-case basis, the person said."

Could someone say what "clearing the trades" mean here?

I think there is something of term-of-art here.

"Clearing brokers" (like Goldman) vet the clients who send transactions to the exchange. If the client defaults on a trade, Goldman is likely liable to the clearing house for the default amount, so it is in their interest to clear only those clients with sufficient collateral to provide margin.

Note that a clearing broker is different from a clearing house. The clearing house serves as a back end settlement layer to an exchange, which serves as a front-end matching engine.

https://www.investopedia.com/terms/c/clearingbroker.asp

Edit: There must be a bona fide finance guy here on HN to answer this knowledgably?

This is the correct answer and only one of two correct answers at the moment.

Aside from the difference between the clearinghouse and the clearing broker, the difference between the executing broker and the clearing broker is also interesting.

For example you might have bank A as your executing broker and they give up the trade to bank B which is your clearing broker. You might even have your own exchange membership and bank B clears the trade for you.

It means they will allow their account at the exchange to settle client trades. This will involve them using their existing collateral at the exchange to underwrite the client trades. They will in turn demand collateral from the client but may be potentially exposed if the client defaults.

It's where Goldman would net off trades between their own clients, effectively acting as an exchange for their clients using the prices on the official exchange. They say in the article they won't act as market-makers or hold their own positions. That means they won't perform their usual capacity for clients, where they act as middleman between the exchange and their own clients. ie they won't make a price for their clients to buy a bitcoin future the client wants to sell, and then turn around and sell the bitcoin to someone else the exchange later in the day. They won't do that. What the will do is buy the bitcoin future if they have another client that wants to buy it at the same time, because then they will never assume much risk.

It’s smart because holding BTC in a Tulip-bulb crisis is insanely risky. This current crisis is due to elastic demand based on short-lived, fashionable attention of a tiny currency, whereas common currencies are more inelastic because their usage and scale lends themselves to more stability. The value will collapse when people lose interest or when large institutions get over the mania of New Relationship Energy. Durable, appreciating assets that are easily liquidated are ideal for holding balance sheet value. For transactions, BTC maybe fine but even that is risky.

It will be interesting to see if shorting will be possible.

I can't see shorting it outright without being wheeled out on a stretcher. Options will be the best play to safely express a bearish position with asymmetric risk/reward assuming they aren't priced to insanely due to IV. Still at least you know your risk.

Just use a stop order:https://support.gdax.com/customer/portal/articles/2426596

There will be some slippage, but it'll be relatively bound.

I assume this is getting downvoted because it won't actually work. Can someone explain why? Can you not use a stop loss like this in futures trading when you short something?

May be a silly question, but I know little about this stuff.

I’m no investor, but one reason I could think as to why it wouldn’t work is once a crash starts, demand would suddenly dry up at the prices you specified and you’d suddenly find yourself with a bunch of orders that can’t be filled.

Yeah. Or worse, you have orders that are filled, but because they are market orders and the market has disappeared, they aren't filled at anywhere close to the price you expected.

At my first job I had a project that involved looking at the actual order book for various stocks on the NASDAQ. There's always some asshole who puts in a limit buy for $0.01 on the hopes that if liquidity dries up, they'll be the best bid and get the stock for literal pennies on the dollar (I've been that asshole, though I've never actually had an order filled at that price). Normally all these orders are completely irrelevant because they're nowhere close to being the best bid, so other buyers get the stock and they just sit there on the order book.

In a flash crash scenario where everybody runs to the exits at once, it's possible for liquidity to completely dry up. The market gets hammered by so many sell orders that they burn through all the people willing to buy at reasonable prices. Then the exchanges dutifully match you up with whoever's left in the order book...which is usually the jokers who are like "Well, I'll put in a limit order for $0.01, leave it there, and see if it ever fills." Because your stop is actually a market order, you take whatever price the market gives you, which is...$0.01. You've just sold your $18K bitcoin for one cent.

This actually happened with the flash crash of 2010, but because market manipulation was proven, NASDAQ halted trading and invalidated the trades that occurred at those prices. There are no such failsafes or means of recovery with Bitcoin.

https://en.wikipedia.org/wiki/2010_Flash_Crash

Stop limits have the problem you mentioned - they just won't get filled in a flash crash, leaving you with Bitcoin that you can't get rid of.

This is exactly what happened with ETH few months back on GDAX. 300 to 200, crashes the site in seconds, triggered pretty much all stop losses and margin calls. When down to a penny.

>There's always some asshole who puts in a limit buy for $0.01 on the hopes that if liquidity dries up, they'll be the best bid and get the stock for literal pennies on the dollar ... Because your stop is actually a market order, you take whatever price the market gives you, which is...$0.01.

Why doesn't everyone do this constantly if it's a possibility? Low chance of such a windfall, but what's the downside?

Basically extremely low chance of windfall, plus transaction costs. Most brokers charge you to place an order; even if the price is just a few pennies, if your chance of that order actually being filled is one in an extremely low number, you're still losing money on the deal. Additionally, "good till canceled" orders (which is what you want to use here) are time-limited on most exchanges, typically to 30 days. That means you need to spend mental bandwidth refreshing them every month, which for something that has an infinitesimal chance of paying out, usually isn't worth it. (I basically let my order lapse after a month because I forgot about it.) The orders exist because out of millions of market participants, somebody's going to place one, but it generally isn't cost-effective for that person to be you.

With regulated exchanges like the major stock ones, you also have to worry about your transactions being invalidated, eg. in the 2010 flash crash nobody who did this actually got paid out because the exchange said "Oops, software glitch" and canceled all transactions before settlement (with the stock market, you don't actually receive the stock until 3 days after you make the transaction).

In addition to the sibling comment, there's a non-trivial risk that, when the crash happens, it's because of a legitimate, non-local drop in value, and you're stuck holding something worthless.

No guarantee what price your stop order will execute at; it's still unbounded risk.

A stop loss will (assuming anyone is willing to take the other side at any price, since it's a market order) get filled once triggered, but depending on market dynamics with potentially unlimited slippage. Slippage tends to be limited in markets with high liquidity, but as I understand Bitcoin on any existing exchange hasn't consistently shown that behavior.

A stop limit order doesn't have unlimited slippage, but may not get filled at all; there is no foolproof stop order.

So if the blockchain evolved such that it took 2 or 3 hours for a transaction to clear, and cost, say, $5,000 then during the same 2-hour block Goldman could let A sell 50,000,000 pretend bitcoins to B, B could sell 25,000,000 pretend bitcoins to C, and 25,000,000 pretend bitcoins to D, then the price could move up (or down) and A could buy back 25,000,000 from C and 25,000,000 from D, so that A, B, C, and D have the same number of virtual bitcoins that they started with - but the exchange could have resulted in a transfer of net actual dollars between A, B, C, and D - without incurring up to 50 million * $5,000 = $250 billion in transaction fees?

Where even though this net transfer happened, all of A, B, C, and D think that it was fair and what they wanted? (I call them "pretend bitcoins" because they don't need to be reflected in the blockchain - the transaction of 25 million pretend bitcoins in motion aren't reflected in the blockchain.)

feel free to correct me if I'm very wrong.

Neither CME or CBOE bitcoin futures are directly connected to bitcoins. Both will be cash settled (i.e. no bitcoin delivery). There will be no need for buyers, sellers or intermediaries dealing in bitcoin futures to buy/sell/own bitcoin.

> It's where Goldman would net off trades between their own clients

This is internalization, which is different from clearing.

Hmm, in trading, internalization is where a broker would fill a buy order from its own inventory instead of acting as the middle man it normally is. So not sure why that idea has been brought up.

To clarify, Goldmans are offering to buy* futures their clients want to sell, if they can line up one of their other clients/counterparties to buy it from Goldmans at the same time. Goldmans is acting only as an intermediary or a broker. The key idea for clients is that if you want to sell, you want to get a quick and good bid from your trading partner. Goldmans are not offering to do that. They won’t make a price straight away for their client, they will only broker trades, so they will need to call up others to find out what their price is, hold them on the line and then offer the price to the client. At the end of the trading day, all Goldmans will do is net off trades between their own counterparties. Goldman clients expect the company usually to act as market maker for futures trades. As a former sell-side trader, what that means is I can make my own prices for the client, buy their futures off them, hold them, and later in the day I can sell them myself, possibly to the exchange. I hold my own position, I assume my own risk, on a short term/daily basis. This is better for the client because they can get an immediate market, they don’t have to wait for me to call someone else.

In a way Goldmans are saying they won’t trade against their own clients. Given their history with the CDOs (think The Big Short), and given how opaque the underlying Bitcoin market is, this seems to me to be a covert reassurance that they won’t be working against their clients.

* or sell obviously.

The important thing about internalization in this context isn't who takes the other side, but the fact that the trade gets done before it even reaches an exchange. You're right that it usually refers to a market maker taking the other side as principal off exchange.

> To clarify, Goldmans are offering to buy* futures their clients want to sell, if they can line up one of their other clients/counterparties to buy it from Goldmans at the same time.

This is not what clearing means. You're talking about execution. They'll still clear the trades even if you execute away. There's not really anything else I can add to this discussion.

An imperfect analogy is that you're buying the futures with a credit card and Goldman will step in and pay the bill if you can't.

Why don't their clients trade directly on the exchange? What value does GS provide here?

> Why don't their clients trade directly on the exchange?

Because to do that with funds in a GS account that you use for trading other things, you have to take the money out, which adds friction?

You still need to clear the trades even if you directly trade on the exchange. It's just not worth the expense for the vast majority of customers to maintain clearing memberships for every single product at every single clearing house.

Clearing is all about novation. This basically means that the buyer and seller don't see each other as counterparties, but only see Goldman as the "middle-man" counterparty. It's a method of reducing counterparty risk, as both parties end up transacting with a credible institution, rather than directly with each other. This also means that the central clearing counterparty takes on counterparty risk, and that's pretty much what the clearing fees are paid to them for.

As a footnote, I'm not sure how Goldman are going to novate the transactions - as in, will they actually issue 2 transactions on the blockchain?! I don't see a real need for that, given that the blockchain protects against such risks to a large extent. Maybe their definition of clearing for bitcoin is different to that for standard derivatives, in which case they will probably just help their non techy clients (i.e. many of the hedge funds in Mayfair and Manhattan) execute bitcoin transactions.

I believed the futures are “cash settled”, basically betting on the price of Bitcoin on other exchanges, not real Bitcoins.

I'm not an expert on the nitty-gritty details of back office stuff, but typically novation comes into play when you're dealing with swaps. These are centrally cleared futures so you're not facing the person on the other side of the trade.

Clearing the trades means both buying and selling.

So they are the market maker?

No, they just serve as a central point to match buyers and sellers so the buyers and sellers don't have to find each other themselves. They aren't making a market but they do get clearing fees.

More like match maker.

No more like a broker. When you buy stocks through your broker, all the broker does is to pass on your order to the exchange, and to report when it was executed. The broker doesn’t take any risk, other than you not making a payment after you gave the buy order.

If the broker was a market maker, he would keep an inventory of that stock and your order would be filled by the broker directly. Who would then report and clear the transaction on the exchange.

Clearing doesn't mean buying and selling.

There's not really a great analogy, but the idea is that Goldman is on the hook if one of their customers can't maintain the margin/haircut.

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