Mt. Gox’s compensation plan will distribute billions of dollars worth of BTC and BCH to Mt. Gox creditors between July 1 and October 31, 2024. This may lead to changes in the supply and demand dynamics of BTC and BCH during these four months, potentially opening up pairing trading opportunities.
Our analysis indicates that the selling pressure on BCH will be four times that of BTC. The assumptions are: 1) Only a small portion of BTC will be sold as most creditors are wealthy Bitcoin holders; 2) 100% of BCH will be sold in the short term due to its weaker investor base.
Pairing long BTC perpetual contracts with short BCH perpetual contracts is the most effective market-neutral way to express this view, unless there is funding rate risk. Those who wish to lock in funding rates can explore other methods such as short-term futures or borrowing BCH in the spot market.
Figure 1: BTC/BCH Ratio Trend
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Source: TradingView, Presto Research
Introduction
The notice regarding the commencement of Bitcoin and Bitcoin Cash repayments issued by Mt. Gox on June 24 clearly stated that the repayments under the so-called “Early Lump Sum Payment (ELSP)” will take place between July 1 and October 31, 2024. This will result in changes in the supply and demand dynamics of BTC and BCH during these four months, potentially creating pairing trading opportunities. This report will delve into this point in detail.
Mt. Gox’s Repayment Plan
Mt. Gox was once the world’s largest Bitcoin exchange until it closed in early 2014 after losing nearly 1 million Bitcoins held by its customers. Some of these assets were later recovered. The trustee is working to repay the creditors according to the plan.
Under this plan, Mt. Gox creditors have the option to receive a slight reduction in compensation based on the assets recovered so far, “in advance” of waiting for “full recovery”. This option, known as the “Early Lump Sum Payment (ELSP)”, is preferred by creditors who want to secure a prepayment. The other option is to hold on and hope for further progress in asset recovery while bearing various risks that may affect the amount of repayment, such as the ongoing CoinLab litigation. As the outcome of both of these issues is uncertain and there is no clear timetable, most creditors prefer to exit early. The highlights of ELSP are as follows (Figure 2).
Figure 2: ELSP Details
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Source: CoinTelegraph, @intangiblecoins, Presto Research
The current consensus is that the repayment of billions of dollars will flood the market and lead to selling, as the recipients of the repayment will cash out in droves.
While such a prospect is certainly unsettling for the market, assessing whether it will actually have a significant impact requires a more careful analysis.
Generally, any so-called “overhang” risk in the market only arises when 1) sellers face time pressure, or 2) the opportunity cost of holding the assets is considered high.
Assessing these two points for the two assets in question, BTC and BCH, we can observe different dynamics at play.
Analyzing Mt. Gox’s Creditors
Our analysis is inspired by the “X” theme by Alex Thorn, Head of Research at Galaxy Digital, which provides an excellent framework for thinking about this issue. We have reproduced his table below and supplemented it with additional data to ensure clarity.
Figure 3: Analysis of ELSP Repayments
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Source: @intangiblecoins, Presto Research
To understand how creditors may behave after receiving the repayment, it is important to have a closer look at who they are. The table above shows that, aside from individual creditors, the two largest groups of creditors are the “Claim Funds” and Bitcoinica. Claim Funds are essentially institutional “vulture funds” that aim to purchase bankruptcy claims at a significant discount. Fortress Investment Group and Off The Chain Capital are major players in the Mt. Gox trade. Claim Funds have accumulated a large number of BTC claims from distressed sellers over the past few years, estimated by Alex to be 20,000 BTC. Bitcoinica was a now-defunct New Zealand Bitcoin exchange that had up to 10,000 BTC in deposits on Mt. Gox.
Alex notes in his post:
His analysis assumes that 75% of the creditors accept ELSP.
Claim Funds are unlikely to sell immediately as their limited partners consist of early Bitcoin holders who are already wealthy and want to accumulate more funds at a discount.
As a defunct exchange undergoing bankruptcy proceedings, Bitcoinica is unlikely to liquidate its holdings.
The current group of individual creditors is likely “high conviction” as they have chosen to hold their claims for ten years, resisting the active bidding of claim funds. There are many opportunities for weaker creditors to exit, and they have likely done so.
Taking into account the above situation, we expand on Alex’s original analysis by adding assumptions on the portion of the repayment that enters the market from creditors. Specifically,
For BTC, we assume only a small portion will be sold due to the aforementioned reasons. For BCH, we assume 100% will be sold in the short term.
(Figure 4). Considering that the Bitcoin Cash fork occurred three years after the Mt. Gox bankruptcy event, the assumption here is that Mt. Gox creditors were not aware of Bitcoin Cash and are more likely to treat their BCH payment as they would any airdrop received, i.e., cash out immediately or exchange for BTC. We apply these assumptions to the data in Figure 3 to derive the potential USD value of the BTC and BCH liquidation. The trading volume for BCH is significantly smaller compared to BTC.
Due to the significantly smaller trading volume of BCH compared to BTC, the selling pressure on BCH will be much higher, with the daily trading value of BTC accounting for 6% and BCH accounting for 24%.
Figure 4: BCH Selling Pressure is 4 Times That of BTC
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Source: @intangiblecoins, Presto Research
The best way to leverage this asymmetric supply risk in a market-neutral manner is to go long on BTC exposure while simultaneously going short on BCH exposure.
This can be expressed in several different ways, but the most effective is through the perpetual futures (perps) market. Perp operators face the risk of funding rate fluctuations, but this risk is easily outweighed by the convenience of quickly establishing and unwinding bilateral bets.
For example, let’s consider expressing this trade through Binance’s USD-M futures. In 2024, the average annualized net funding rate for long BTCUSDT perpetual contracts and short BCHUSDT perpetual contracts is 13% (Figure 5). If you enter this trade for three months, the breakeven threshold would be 3.25%. Given that the current BTC/BCH ratio is 161, a local high at a ratio of 193 (+20% upside) would clear the hurdle rate and generate a market-neutral return of 17% after deducting financing costs. The historical high for this ratio was 252 in May 2023.
Figure 5: Financing Cost for Pairing Trade
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Source: Binance, Presto Research
Additionally, those who wish to lock in funding rates can explore other methods such as short-term futures or borrowing the underlying asset in the spot market. Some exchanges offer BCH/BTC currency pair trading, although liquidity is lower (Figure 6).
Figure 6: BCH/BTC Trading Pair with 24-hour Trading Volume of $2.3 million
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Source: Binance