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jheff

Hedging Instruments

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First time poster but long time lurker. As someone with extensive experience in the financial services industry i want to bring up one point i think everyone is missing in terms of what needs to happen on the regulatory side of things for banks and FIs to use xRapid (and therefore XRP)

HEDGING INSTRUMENTS! by law, banks are limited to how much risk they can take. there is a concept called VaR (value at risk). it is a statistical measure of how "exposed" and to what magnitude of exposure banks have. banks hedge every position they take. this is the exact reason options, futures, forwards, swaps and other OTC contracts were created. if you can hedge a position cheaper than it would cost for your position to go to zero, you're going to do it. essentially, you trade the "tail" ends of the probability distribution of returns (upside and downside) for less exposure to drastic swings in marked to market position value. 

aren't these instruments supposed to be created by ripple in 2018? if so watch out. before this happens, no major player in the world of banking is even allowed to touch XRP.

 

 

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Yes, Ripple is working on this issue. IIRC, I think they said in Q1, or maybe it was just a general 'in 2018'. Would have to go look at the Q4 report to see their wording. Also, others are moving forward on hedging products. SBI are opening a hedging business. I believe CBOE is looking to extend the futures they offer, presumably they'd include Ripple. And I think Genesis now offer some hedging instruments.

Agreed, most people miss this point but it has been discussed on and off here.

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Also, with hedging instruments its much easier to have exposure in underlying assets to short it.
And fact is, that banks can always have options, forwards etc., because they can be OTC.

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6 hours ago, mediator_mba said:

Also, with hedging instruments its much easier to have exposure in underlying assets to short it.
And fact is, that banks can always have options, forwards etc., because they can be OTC.

Right. So do you think this means that issuing derivatives on XRP would be a bad thing? You're right about investors being able to take short positions, but I think that issuing options on XRP would only increase the likelihood they're used by banks since they could hedge price risk with protective puts. Since the transactions would take only a few seconds, Ripple could issue options with time to maturities of one minute or an hour. Volatility would be high but since time to maturity would be so low, banks could hedge their ~5 seconds of exposure relatively cheap. 

I know what you're saying about OTC contracts being customizable, but since there isn't demand for these instruments the premiums in OTC market wouldn't make it worth it IMO. Correct me if I'm wrong, but I don't even think the short side of these contracts would be taken by anyone at this point. 

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Derivatives is a crap IMO, just look back into 2008 and CDO, other derivatives.

My only opinion, that if banks use xrp for transferring money, they use predefined exchange rate and hedging not necessary. 
But if banks want to invest in crypto, they should use derivative because of regulatory issues and unregulated crypto market nature.

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2 hours ago, jheff said:

Right. So do you think this means that issuing derivatives on XRP would be a bad thing? You're right about investors being able to take short positions, but I think that issuing options on XRP would only increase the likelihood they're used by banks since they could hedge price risk with protective puts. Since the transactions would take only a few seconds, Ripple could issue options with time to maturities of one minute or an hour. Volatility would be high but since time to maturity would be so low, banks could hedge their ~5 seconds of exposure relatively cheap. 

I know what you're saying about OTC contracts being customizable, but since there isn't demand for these instruments the premiums in OTC market wouldn't make it worth it IMO. Correct me if I'm wrong, but I don't even think the short side of these contracts would be taken by anyone at this point. 

I also have a lot of experience in financial services.

As the price rises, I see futures and options on futures as not out of the question.  But, at a low cost per coin, they're not worthwhile.  So, it'll take a while to see these, IMO.

My thinking is that the resumed focus on Codius will be the way Ripple addresses the hedging need for XRP.  Smart contracts are more flexible than any derivative product.

As financial services people, we tend to think of securities as the solution, but smart contracts can do everything a futures contract can, everything an options contract can, everything a swap can; all of it, all at once, in any amount and denomination.  You can design them to hedge anything. And, you don't need to leverage (although you can do that too).

So, IMO, when Codius is ready, you will see the beginning of an era where the smart contract replaces the old school derivative for most institutional use cases where leverage is not desired and a few cases where it is.

Edited by ReformedEquityTrader
Stupid auto correct

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15 hours ago, jheff said:

First time poster but long time lurker. As someone with extensive experience in the financial services industry i want to bring up one point i think everyone is missing in terms of what needs to happen on the regulatory side of things for banks and FIs to use xRapid (and therefore XRP)

HEDGING INSTRUMENTS! by law, banks are limited to how much risk they can take. there is a concept called VaR (value at risk). it is a statistical measure of how "exposed" and to what magnitude of exposure banks have. banks hedge every position they take. this is the exact reason options, futures, forwards, swaps and other OTC contracts were created. if you can hedge a position cheaper than it would cost for your position to go to zero, you're going to do it. essentially, you trade the "tail" ends of the probability distribution of returns (upside and downside) for less exposure to drastic swings in marked to market position value. 

aren't these instruments supposed to be created by ripple in 2018? if so watch out. before this happens, no major player in the world of banking is even allowed to touch XRP.

 

 

Miguel Vias came from the CME, i think he has an idea or two about working with banks to hedge balance sheet risk. Also, my hope is that VaR will be tweaked (or some alternative is found) so a normal distribution isn't relied upon with digital assets. Anything based on MPT and standard deviations is asking for trouble. '08 showed how flawed they are...do the whole thing over with crypto and grab the popcorn.   

Edited by XRPonTheIronThrone

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