An Introduction to Leveraged Trading on the Blockchain

Table of Links

Abstract and Introduction

1 Literature Review

2 Methodology and Artefact Requirements

3 The Implementation and Integration of the Artefact

4 Artefact Evaluation

5 Discussion

6 Conclusion and Future Work, and References

Abstract

We document an ongoing research process towards the implementation and integration of a digital artefact, executing the lifecycle of a leveraged trade with permissionless blockchain technology. By employing core functions of the ‘Dai Stablecoin system’ deployed on the Ethereum blockchain, we produce the equivalent exposure of a leveraged position while deterministically automating the monitoring and liquidation processes. We demonstrate the implementation and early integration of the artefact into a hardened exchange environment through a microservice utilizing standardized API calls. The early results presented in this paper were produced in collaboration with a team of stakeholders at a hosting organization, a multi-national online brokerage and cryptocurrency exchange. We utilize the design science research methodology (DSR) guiding the design, development, and evaluation of the artefact. Our findings indicate that, while it is feasible to implement the lifecycle of a leveraged trade on the blockchain, the integration of the artefact into a traditional exchange environment involves multiple compromises and drawback. Generalizing the tentative findings presented in this paper, we introduce three propositions on the implementation, integration, and implications of executing key business processes with permissionless blockchain technologies. By conducting computational design science research, we contribute to the information systems discourse on the applied utility of permissionless blockchain technologies in finance and beyond.

Introduction

Leveraged trading is the practice of amplifying the buying power in a portfolio of assets, by trading with borrowed funds. Leveraged, or margin trading, is typically employed by traders in bridging liquidity gaps or towards the aim of achieving additional exposure to selected assets. A leveraged trade is generally executed as a non-discretionary unilateral agreement between a trader and a brokerage platform in which the trader is issued a short-term loan against the value of a collateral or margin account. The trader maintains a collateral account with the brokerage, against which the brokerage facilitates leveraged trading, either directly on the spot markets or by utilizing a set of regulated derivatives such as contracts-for-difference (CFD) or futures contracts of variable maturities. In most cases, the trader can continue trading with borrowed funds, so long as the value of the collateral or margin account exceeds any losses incurred through the depreciation of the trader’s open positions.

If, at any point, the value of the open positions held by the trader drops below a certain lower bound, the brokerage or lender will typically issue a margin call. If, after one or more attempts, the margin call is not met, the brokerage or lender will seek to liquidate the trader, by closing positions in the trader’s portfolio while withholding any collateral assets to recoup the initial loan. Brokerage and exchange platforms have emerged as powerful players in leveraged or margin trading, processing a significant portion of the +$60 trillion global volumes traded in equities annually.

In the highly volatile crypto-currency markets, traders with a significant appetite for risk can find exorbitant leverage multiples on unregulated exchanges, multiplying the buying power of their capital with up to excessive amounts. Because unregulated cryptocurrency exchanges can unilaterally control the execution logic of the agreement, cases have emerged in which covert service providers have offered derivative transactions with 100x leverage multiples and beyond[1], capitalizing on aggressive liquidation systems in which the trader’s margin or collateral assets are unfairly seized prior to an actual liquidation event[2].

In this paper, we document an ongoing effort towards examining the feasibility of implementing the lifecycle of a leveraged position, with blockchain technology. Utilizing the design science research methodology, we design, develop, and evaluate a digital artefact comprising trading infrastructure for blockchain-based decentralized leverage. We utilize the Dai stablecoin system deployed on the Ethereum blockchain to execute the full lifecycle of a leveraged trade in the deterministic and transparent computational environment afforded by the Ethereum blockchain. The artefact is the result of an ongoing development process conducted between the authors and a team at a hosting organization, a leading international brokerage platform. We address the research question: To what extent can blockchain technology improve the execution of a leveraged trade? To this end we (i) demonstrate an implementation of a leveraged trade on the Ethereum blockchain using the Dai stablecoin system (ii) demonstrate and discuss the efforts towards integrating the implementation in a traditionally ‘hardened’ exchange infrastructure, and (iii) evaluate the challenges and compromises required in the implementation and integration of permissionless blockchain technologies in the enterprise setting.

Generalizing the findings produced in this ongoing work for future IS research, we present three propositions on the implementation, integration, and impact of permissionless blockchain technology. By conducting computational design science (Rai 2017) we aim to contribute novel insights towards the growing discourse on the design processes for digital artefacts utilizing blockchain technologies. Specifically, we aim to stimulate further discourse on the discrepancies between permissionless technologies and enterprise infrastructure. We maintain that design driven and empirical IS research is vital in generating applied perspectives on the efficacy of emerging IT infrastructure. Given the aptitude for interdisciplinary and problem-oriented scholarship, the IS community is exceptionally well positioned to explore the potential of innovative digital technologies in the financial industries and beyond.

[1] https://www.cftc.gov/PressRoom/PressReleases/8270-2

[2] https://www.bitmex.com/app/liquidation#Liquidation-Process